financial stability report 2015 - · pdf file7 introduction financial stability report 2015...

Podgorica, 2016

FINANCIAL STABILITY REPORT 2015

PUBLISHED BY: Central Bank of Montenegro Bulevar Svetog Petra Cetinjskog 6 81000 Podgorica Telephone: +382 20 664 997, 664 269 Fax: +382 20 664 576

WEB SITE: http://www.cbcg.me

CENTRAL BANK COUNCIL: Milojica Dakić, MS, Governor Nikola Fabris, PhD, Vice-Governor Asim Telaćević Milivoje Radović, PhD Milorad Jovović, PhD Srđa Božović, PhD

DESIGNED BY: Andrijana Vujović Nikola Nikolić

TRANSLATED BY: Translation Services Division

PRINTED BY: Studio Branko d.o.o. Podgorica

PRINTED IN: 100 copies

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

ABBREVIATIONS

ARIMA model Autoregressive integrated moving average modelAED Dirham, currency of the United Arab EmiratesGDP Gross Domestic ProductCBCG Central Bank of MontenegroCDS Credit default swap CHF Swiss Franc DNS Deferred net settlement EBRD European Bank for Reconstruction and Development ECB European Central Bank EIB European Investment BankEMU Economic and Monetary Union EONIA Euro overnight index average EPCG Electric Power Company of Montenegro EU European UnionEUR Euro EURIBOR Euro interbank offered rateFED Federal ReservesFOMC Federal Open Market CommitteeGBP Pound Sterling (H)CPI (Harmonised) Consumer Prices Index JPY Japanese YenKAP Aluminium Plant Podgorica KfW Kreditanstalt für Wiederaufbau LIBOR London interbank offered rate MF Ministry of Finance MFI Micro-credit financial institutions IMF International Monetary Fund MSCI Morgan Stanley Capital International NOK Norwegian Kroner VAT Value added tax PPP Purchasing power parity RESET Regression equation specification error test ROAA Return on Average Assets ROAE Return On Average EquityRTGS Real Time Gross SettlementUSA United States of AmericaFDI Foreign Direct Investments OF MN OGM Official Gazette of Montenegro UK United KingdomUSD United States Dollar VIF Variance inflation factor WIIW Wiener Institut für Internationale Wirtschaftsvergleiche ZZZ Employment Agency

CONTENTS

INTRODUCTION 7

1. INTERNATIONAL ENVIRONMENT 9

1.1. Overview of Macroeconomic Developments 9

2. MACROECONOMIC DEVELOPMENTS IN THE COUNTRY 23

2.1. Economic Activity Developments 232.2. Inflation 302.3. Fiscal Deficit/Surplus 352.4. Public Debt 382.5. Balance of Payments 392.6. Real Estate Market 40

3. FINANCIAL SYSTEM 47

3.1. Banking System 473.1.1. Capital 483.1.2. Banking Sector Profitability 503.1.3. Total Assets and Liabilities Structure 523.1.4. Credit Risk 573.1.5. Liquidity Risk 603.1.6. Market risks 623.1.7. Interest rates 66

3.2. Micro-credit financial institutions 693.3. Capital Market 703.4. Insurance Sector 72

4. FINANCIAL INFRASTRUCTURE 73

4.1. Payment System 734.2. Credit Registry 75

5. CONCLUDING REMARKS 77

5.1. Policies for preservation of financial stability 81

7

Introduction Financial Stability Report 2015

INTRODUCTION

Financial stability is the fundamental prerequisite for economic development. Essentially, financial stability approach means that monetary policy creators analyse and prevent the occurrence of all tho-se events that may pose threat to financial stability via monetary and economic policy measures. This approach generally implies two dimensions of financial stability: micro-dimension that addresses ri-sks from the aspect of individual financial institutions and macro dimension that observes risks from the aspect of the overall financial system. The objective of such a two-dimensional approach is to pro-perly assess systemic risk, i.e. the risk of spilling illiquidity or insolvency problem from an individual institution over to the entire system. The financial stability approach that is also applied by the CBCG may be presented through the following scheme:

Schematic 1 – Framework for maintaining financial stability

Source: Schinasi, G., 2005, „Preserving Financial Stability“

With a view to achieving financial stability, it would be necessary to identify potential risks before they appear and result in a crisis or problems in the financial market functioning. This means implemen-ting preventive and timely well-dimensioned policies. Of course, the objective cannot be to prevent all potential problems in the financial market because it is impossible to manage all risks and uncertain-ties, and there is also no market that has not undergone fluctuations or turbulences. Therefore, efforts should be put on minimizing the biggest risks and ensuring system vitality in case of a crisis. Thus,

8

Central Bank of Montenegro Financial Stability Report 2015

the very objectives of the Financial System Stability Report as well as activities of the CBCG in this area are preventive actions and identification of the most important risks before their materialisation.

9

International Environment

1. INTERNATIONAL ENVIRONMENT

1.1. Overview of Macroeconomic Developments

In 2015, the global economy grew at a rate lower than in 2014. Estimated growth rate amounted to 3.1%,1 which has been revised 0.4 percentage points downwards since 2015. Advanced economies grew at the rate of 1.9%, while the growth rates for the emerging/developing countries was 4.0%.

Table 1.1

Overview of main global indicators, y-o-y, %

Indicator 2014 2015Forecast

Differences from October 2015 projections,

percentage points

2016 2017 2016 2017

GDP growthWorld 3,4 3,1 3,4 3,6 -0,2 -0,2

Advanced economies 1,8 1,9 2,1 2,1 -0,1 -0,1

Emerging and Developing economies 4,6 4,0 4,3 4,7 -0,2 -0,2

USA 2,4 2,5 2,6 2,6 -0,2 -0,2

Euro area 0,9 1,5 1,7 1,7 0,1 0,0

Germany 1,6 1,5 1,7 1,7 0,1 0,2

France 0,2 1,1 1,3 1,5 -0,2 -0,1

Italy -0,4 0,8 1,3 1,2 0,0 0,0

Spain 1,4 3,2 2,7 2,3 0,2 0,1

Japan 0,0 0,6 1,0 0,3 0,0 -0,1

UK 2,9 2,2 2,2 2,2 0,0 0,0

Canada 2,5 1,2 1,7 2,1 0,0 -0,3

Advanced economies outside G7 and euro area 2,8 2,1 2,4 2,8 -0,3 -0,1

Emerging and Developing economies 2,8 3,4 3,1 3,4 0,1 0,0

Russia 0,6 -3,7 -1,0 1,0 -0,4 0,0

China 7,3 6,9 6,3 6,0 0,0 0,0

India 7,3 7,3 7,5 7,5 0,0 0,0

Latin America and the Caribbean 1,3 -0,3 -0,3 1,6 -1,1 -0,7

Middle East, North Africa, Afghanistan, and Pakistan 2,8 2,5 3,6 3,6 -0,3 -0,5

Sub-Saharan Africa 5,0 3,5 4,0 4,7 -0,3 -0,2

Volume of global trade (goods and services) 3,4 2,6 3,4 4,1 -0,7 -0,5

Consumer pricesAdvanced economies 1,4 0,3 1,1 1,7 -0,1 0,0

Emerging and Developing economies 5,1 5,5 5,6 5,9 0,5 1,0

Source: World Economic Outlook (WEO) Update, IMF, January 2016

1 According to the IMF’s World Economic Outlook Report, updated in January 2016

10


Lower growth rates primarily resulted from lower growth rates of emerging/developing countries, which weight for the calculation of global growth rate was higher compared to the advanced econo-mies. Contrary to that, although moderate and uneven, economic growth of developing countries was higher than in 2014. The volume of global trade substantially declined year-on-year.

Main risks that marked 2015 will largely influence the global economic activity in 2016 as well, invol-ving a further decline in the prices of energy generated products and commodities, an increase in the FED interest rates, a deceleration and budget review of Chinese economy, and geopolitical risks.

A decline in oil prices was more evident in H2 2015 mostly due to a higher supply as a result of strate-gic policies of main oil producers. Surely, oil and other commodity prices influence inflation outlooks and thus expectations concerning monetary policy developments. Globally speaking, a positive effect should be evident through available profit and corporate revenues instigating private consumption and investments in countries importing energy generated products. On the other hand, such price in the exporting countries usually slows down or delays new investments in energy sector. Currencies of these countries are more or less dependant on oil price developments. In addition, strengthening of the U.S. dollar would increase pressure on the commodities prices.

According to the IMF, low commodities prices could lower growth rate in commodities of exporting countries up to 1% in the period 2015-2017 as compared to 2012-2014, whereby a decline in growth rate of energy generated products of exporting countries could be even up to 2.25%.

The aluminium price declined 21.6% y-o-y and it amounted to USD 1,497.2 per tonne.

2 HIPC for the euro area countries, IPC for the USA

Commodities prices (2005 = 100), 2014-2015

Graph 1.1

Source: IMF

Consumer price indices of selected countries2, %, 2014-2015

Graph 1.2

Source: Eurostat, U.S. Bureau of Labor Statistics

11


Develped countries continued recording low inflation rates and deflation in 2015, primarily under the influence of a decline in the prices of energy generated products. The annual inflation rate in H2 2015 increased both in the euro area and the USA although these are inflation rates that are still far away from the medium-term objective of the Eurosystem’s and the FED’s monetary policies. The purchase of government securities in the secondary market, the so-called „quantitative easing“ was introduced in the euro area, and the rate on overnight deposits of banks held with the Eurosystem declined from -0.2% to -0.3% in December 2015.

However, this programme was completed in the USA due to better economic results and inflation projections in the medium-term. The FED passed a decision on increasing the reference interest rate by 0.25 percentage points at end-2015, which was the first increase in this rate since December 2008.

China s economy recorded a further slowdown in 2015, while the estimated growth rate amounted to 6.9% which was the lowest rate in the last 25 years, while the IMF forecasts pointed to further dece-leration in 2016 and 2017. Generally speaking, China s economy grew at the expected rates, whereas exports and particularly imports dropped substantially and indicated weaker investments and in-dustrial output. China’s economic slowdown undoubtedly affected the global growth and its major trading partners (EU, USA and Japan) through trading channels, as well as the commodities prices, thereby affecting the countries whose main sources of revenues are commodities.

The transformation process of the Chinese economy from an export-driven into a consumer-driven economy was partially successful. The consumption was rather high during 2015, as compared to the investments and industrial output. The Chinese authorities had been trying to actively shape econo-mic developments for a long period using numerous stimulation measures that did not always yield desirable results. Enormous FX reserves were used to defend the exchange rate appreciations, which divided the opinions of analysts. A substantial USD debt of the economy could, with the depreciation of the local currency, result in serious repercu-ssions both in the real sector and banks where the level of non-performing loans have been alre-ady posing a concern. In this situation, a further increase in the reference interest rate in the USA poses a high risk (China is not the only emer-ging/developing country exposed to this type of risk). On the other hand, a significant amount of FX reserves was spent to maintain the exchange rate in 2015. In addition, there was a high capital outflow that could continue in 2016.

The euro area and its largest economies repor-ted better results during 2015 when compared to 2014. The growth was based on higher private spending and exports in some countries which was positively affected by low oil prices, a weaker Euro exchange rate, and favourable borrowing possibilities. The European Commission estima-ted a rate of growth of 1.6% for 2015, while the continuance of economic recovery in the euro

GDP growth rates of selected countries, Q/Q-4, %, 2014-2015

Graph 1.3

Source: Eurostat, US Bureau of Economic Analysis

12


area is expected in 2016 and 2017, with a mode-rate growth rates of 1.7% and 1.9%, respectively. The U.S. economy continued to grow in 2015 with rather high rates and it managed to maintain momentum from the previous years. Economies of the regional countries with which Montenegro has significant trade reported positive growth ra-tes and the prospects for 2016 and 2017 are rela-tively good.

Box 1.1 - Current positions of some economies compared to the Great Recession

The Great Recession (at the time of occurrence called the Global economic crisis) is a period from the end of the first decade of the 21st century, which was characterised by a fall in economic activity of developed economies and a slowdown of growth in emerging and developing economies. The Great Recession corresponds with the Global financial crisis, i.e. the U.S. subprime mortgage crisis which were essentially the triggers of the Great Recession.

The Great Recession did not start simultaneously nor did it last equally in all countries. The leading global economies, the USA and the UK were hit first, followed by Italy and Japan, which reported nega-tive growth rates already in 2008, but developed countries, as a group, recorded a positive growth rate of 0.2%. The recession deepened in these countries in 2009 and emerged in almost all other developed economies. Growth rates of the emerging and developing economies, although declining, compensat-ed for the negative growth of developed economies, thus the global growth rate in 2009 was slightly above zero which was, however, the worst growth rate in the world after World War II.

The rate of growth of European emerging and developing countries amounted to -3% in 2009, whereas the growth rate of the Montenegrin economy was -5.7%. With regard to this group of countries, only Poland, as well as Albania and Kosovo (two countries with the lowest convergence level compared to developed countries), reported positive growth rates in this year.

In 2015, various countries are on different positions compared to 2008 as the year preceding the 2009 crisis year. The U.S. economy reached in 2011 the GDP level from 2008 (measured by constant prices), while the estimates showed that the euro area reached this level not before in 2015. Montenegro`s economy reached the 2008 real GDP level in 2013.

GDP growth rates of regional countries, Q/Q-4, %, 2014-2015

Graph 1.4

Source: National Statistical Offices

13


If the analysis included the number of citizens, i.e. real GDP per capita, the situation would be some-what different and countries that recorded declines in the number of citizens over the same period reported better per capita results and vice versa.

Table 1

GDP change in constant prices, 2015/2008, %

Country GDP GDP per capita

Albania 18.5 25.6

Bosnia and Herzegovina 3.4 4.7

Bulgaria 2.4 8.7

Montenegro 5.3 3.8

France 3.2 -0.1

Greece -27.1 -25.5

Croatia -11.8 -10.2

India 64.9 48.2

Italy -7.2 -10.

Japan 2.3 3.4

China 75.9 69.9

Kosovo 25.9 -

Macedonia 15.3 14.0

Germany 6.1 6.5

Romania 3.0 7.0

Russia 1.8 -0.7

USA 10.4 4.7

Slovenia -4.7 -7.1

Spain -3.1 -4.0

Serbia -1.0 1.6

UK 7.1 1.3

World 25.3 -

Euro area 0.2 -

European Union 2.6 -

Source: IMF, CBCG calculations

In 2015, almost all euro area countries reported a decline in unemployment.3 The unemployment rates declined in four largest economies of the euro area (Germany, France, Italy and Spain), whereby the unemployment rate in Germany (4.5% at end-2015) indicated high competitiveness of the German economy at the global level. On the other hand, Spain had an extremely high rate of 20.8% with a decli-

3 The latest available monthly data were taken for December 2015 unemployment rates for drafting this report.

14


ne of 2.8 percentage points annually. Unemployment was still high in Greece (24.6% in November), Croatia (16.6%), Cyprus (15.7%), and Portugal (12.2%).

Unemployment declined in the USA also in 2015 (down to 5%), thus continuing a gradual down-trend from Q4 2009 when it reached 10%. The unemployment rate is one of the main monetary policy indicators of the FED. Although the cu-rrent level of unemployment indicates the dyna-mic economic activity, analysts have certain di-sagreements concerning the adequacy of such in-dicators and potential differences from the actual position of the labour market - fewer new em-ployees in manufacturing industry, a low labour force-to-working age ratio, a high so-called „U6“ unemployment rate4 and the like. The unem-ployment rate also dropped in Japan, by 0.1 per-centage points and it amounted to 3.3% although it should be pointed out that the unemployment rate is not the primary problem of the Japanese economy but rather deflation risk and weak eco-nomic growth (which is, rather atypically, achie-ved together with low unemployment rates).

In 2015, the current account deficit in most euro area countries declined, while surpluses increa-sed. Of the largest euro area countries, only Fran-ce reported a deficit, which was trending down. Greece, which had an enormous current account deficit, substantially improved its position. Such a situation in the euro area resulted from lower commodity prices and higher competitiveness of export products considering weaker Euro.

Positive developments in state finance continued also in 2015 not only with leading economies but also with the periphery countries. Graphs 1.7 and 1.8 below show a summary of state finance de-velopments in the euro area countries. It is clear that the process of fiscal consolidation continued and fiscal deficits are currently substantially lower. In addition, lower deficits bring about lower borrowings, so there is a slowdown of growth and, in certain cases, government debt declines. Howe-

4 A wider concept of the `unemployment rate definition which also covers a group of the so-called marginally attached employees, like those "discouraged" to look for a job, and also part-time employees.

Unemployment rates of selected countries, 2008-2015,%

Current account deficit of the euro area selected countries, % of GDP

(2011-2016; 2016 presented in grey)

Graph 1.5

Graph 1.6

Source: Eurostat, U.S. Bureau of Labor Statistics

Source: European Commission - Winter Forecast 2016 (February 2016)

15


ver, even stronger consolidation is required in most countries, since the levels of government debt of some countries are extremely high. On the other hand, growth in public sector debt, which was higher than government debt in many of the euro area countries generally stopped or slightly declined.

Box 1.2 - Public finances and current account balances in economies in the region5

Public finances of the regional countries - Albania, Montenegro, Macedonia, and Serbia as candidate countries, and Croatia and Slovenia as EU member states - are not satisfactory.

All of the mentioned countries recorded fiscal deficits, whereas a declining trend in the following two years is expected. Observed through public debt, perhaps as a better structural indicator of soundness of the public finances, Macedonia is the only country better than Montenegro for which the European Commission estimates the public debt to GDP ratio of 61.4% in 2015, with an uptrend in the following two years. On the other hand, Croatia, Slovenia, and Serbia are already in a „danger zone“ of close to or above 80%. Both EU and euro area have already exceeded the Maastricht Criteria of 60% and they are currently close to or beyond 90%.

Large number of analysts believe that poor situation in the public finances results basically from the external non-competitiveness of European countries, while, in their opinion, recapitalisations/nation-alisations of banks in the crisis period were in a certain way also the result of external non-competi-tiveness. Aggregately, the EU or euro area countries currently have positive current account balances, whereby core countries (Germany, Austria, the Netherlands) are still better compared to the periphery

5 The analysis in this box is given on the basis of the European Commission’s data, which in the case of Montenegro do not correspond completely with the data of the official domestic institutions. As this is probably the case also with the data from other countries, the European Commission’s data are fully kept due to the consistency of the source for all observed countries.

Fiscal deficit of selected countries in the euro area, % of GDP (2011-2016;

2016 presented in grey)

Government debt of the euro area selected countries, % of GDP (2007-2016;

2016 presented in grey)

Graph 1.7 Graph 1.8



16


countries (Greece, Italy, Spain and Portugal). In that respect, the situation in countries in the region, as well as in the entire EU an the euro area is much better than in the pre-crisis period (as the period of extremely high consumption) although their economic growth is smaller relative to the above men-tioned period. With regard to the regional countries, Montenegro has the most obvious current ac-count deficit. As for larger economies, Serbia had the largest deficit, that in Macedonia is slightly above zero, while Croatia and Slovenia in particular, report significant surpluses in their current accounts.

Table 1

Public finances and current account balances in the regional economies, % of GDP

CountryBudget balance Gross public debt Current account balance

2015 2016 2017 2015 2016 2017 2015 2016 2017

Albania -3,5 -2,3 -1,8 72,3 71,6 69,9 -10,9 -11,9 -12,3

Montenegro -7,0 -6,6 -6,1 61,4 65,8 68,9 -12,9 -13,4 -13,9

Croatia -4,2 -3,9 -3,2 86,0 87,0 87,4 4,2 3,1 3,2

Macedonia -3,8 -3,5 -3,1 39,6 40,8 41,6 0,2 0,2 0,1

Slovenia -2,9 -2,4 -1,9 83,5 79,8 79,5 6,9 7,2 6,9

Serbia -3,8 -3,7 -3,5 76,2 79,9 81,8 -5,1 -4,9 -4,9

EU -2,5 -2,1 -1,7 87,2 86,9 85,7 2,1 2,1 2,0

euro area -2,2 -1,9 -1,6 93,5 92,7 91,3 3,7 3,6 3,4

2015 - estimate, 2016-2017 - forecast

Source: European Commission - Winter 2016 European Economic Forecast

Financial Markets and Monetary Policy

Developments in the global economy during 2015 showed still strong influence of the largest central banks, which decisions are important for both national and global markets.

With the aim of achieving targeted inflation in medium-term, the European Central Bank passed a decision at the beginning of December 2015 to cut the interest rate on overnight deposits (deposit fa-cility) by 0.1 percentage points to -0.3%. The main reference interest rate remained the same. It was decided to continue with the quantitative easing programme until 2017, i.e. until the Governing Coun-cil of the ECB deems it necessary. In addition, a decision was passed to expand the spectrum of public sector instruments qualifying for the Public Sector Purchase Programme to include market debt of regional and local governments. On the other hand, at its meeting held in the middle of December 2015, in accordance with market expectations and previous announcements, the Fed s FOMC passed a decision to increase the reference interest rate by 0.25 percentage points to range from 0.25% to 0.5%, which represented the first increase of the reference interest rate since December 2008. Taking into consideration certain „shifts“ in domestic and international markets, the FOMC explained that its decision resulted from the significant progress in the labour market and expectations concerning inflation growth up to a targeted level in the medium-term. The central banks of England and Japan continued to keep their reference interest rates at extremely low levels of 0.5% and 0-0.1%, since March 2009 and December 2008, respectively.

17


Reference interbank rates moved pursuant to the monetary policy directions. The EONIA and the EURIBOR were at their record low levels - the EONIA ranged from 0.09% to -0.24%, while the 3M EU-RIBOR ranged between 0.08% and -0.13%.

The six-month USD LIBOR grew over the year, particularly in the last quarter, which resulted in market expectations and finally an increase in the Fed s reference interest rate. The six-month LIBOR ranged from 0.35% to 0.85%.

The connectivity and influence of the Chinese economy on the global economy was particularly evident in the financial markets in 2015. The failure of Chinese SSE composite index, which occurred in the middle of June 2015, has had swift and big reflection in global capital market. The American market, as the market with greater depth and reliability, showed a relatively strong resilience to the initial failure of the Shanghai in-dex. However, at end-August, influenced by seve-ral simultaneous factors (lower commodities pri-ces, low inflation, lower values of most Asian cu-rrencies against the USD, uncertainties regarding the monetary policy in the USA), the U.S. capital market recorded an enormous three-day decline.

Reference interest rates of central banks,%, 2014-2015 Reference market interest rates, %, 2014-2015

MSCI global indices, 2014-2015

Graph 1.9 Graph 1.10

Graph 1.11

Source: Bloomberg Source: Bloomberg

Source: Bloomberg

18


Soon afterwards indices recovered but they were still below the average values for the first two qu-arters of 2015, which was particularly evident in the European markets. Volatility also gradu-ally declined until changes in the FED s and the ECB s interest rates. At end-December 2015 and in early 2016, a new large fall of leading indices occurredand the majority of indices came close to their levels back in 2013.

During 2015, Euro depreciated in nominal terms against the leading global currencies, the USD, JPY, GBP, and CHF by 10.2% (from 1.2098 to 1.0857 USD against 1 EUR), 9.9%, 9.5%, and 5.1%, respectively. The variance ratio against above mentioned currencies amounted to 2.6%, 2.5%, 3.3% and 2.5%, respectively. Somewhat higher variance was noted in the Euro exchange rate against Swiss Franc, primarily due to trading af-ter the announcement of the Swiss National Bank that it would no longer ban the strengthening of Swiss Franc against Euro starting from the midd-le of January 2015.

Indicators of volatility/stress at the financial markets, 2014-2015

Graph 1.12

Source: Bloomberg

Euro against other currencies, 2014-2015, 1 January 2014=100 (growth/decline shows

strengthening/weakening of Euro)

Yields on 10-year government bonds, %, 2014-2015


Source: Bloomberg, CBCG calculations Source: Bloomberg

19


Yields on 10-year bonds of majority of the euro area countries dropped during 2015. The U.S. 10-year government bonds yield amounted to 2.2% at end-2015, which represented an attractive risk premium to investors on equivalent German and Swiss bonds that yielded 0.27% and -0.06% at end of the year, respectively. This could influence further strengthening of the U.S. dollar or weakening of the Euro. The price of gold amounted to 1,061.1 U.S. dollar per fine ounce at end-2015.

Box 1.3 – The ECB`s monetary policy and Euro interest rates

The European Central Bank maintained the policy of record low interest rates in 2015, whereby the main refinancing operations rate remained at 0.05% throughout the year, while the rate on overnight deposits of banks held with the Eurosystem dropped in December from -0.2% to -0.3%. This directly reflected on market interest rates, thus the EONIA and the 3-month EURIBOR were at their record low levels; the EONIA stood at 0.14% at the beginning of the year and -0.13% at the end of the year, while the EURIBOR was 0.08% at the beginning and -0.13% at the end of the year. Thus the ECB influenced a decline in Euro interest rates on deposits held with banks in the European market, while interest rates on deposits of individual banks were formed depending on the maturity of individual types of deposits and credit ratings of banks.

In addition to the interest rates policy, and af-ter further weak outlooks for the price levels and economic activity in the euro area, the ECB started with the quantitative easing pro-gramme in 2015, i.e. the purchase of govern-ment securities in the secondary market. This programme started on 21 March as an upgrade of another two asset purchase programmes, the Third Covered Bond Purchase Programme and Asset-Backed Securities Purchase Pro-gramme that started in October and November 2014, respectively. Asset purchase will last at least until March 2017 and maybe even longer, depending on the economic situation. Monthly purchase was about 60 billion euros, and asset purchase through these programmes amount-ed to about 650 billion euros at end-2015. This mostly resulted in an increase in total assets of Eurosystem from 2.2 trillion euros to 2.8 trillion euros during 2015.

The ECB intended to cut further the level of lending interest rates through quantitative eas-ing and boost investments and private sector spending through better financing conditions, simultaneously cutting deposit interest rates, which generally discourages savings. The ECB evaluated that the programme currently meets the expecta-tions. However, one gets the impression that such quantitative easing policy, together with the current policy of low reference interest rates, additionally distorts market of Euro interest rates on government securities, i.e. it unnaturally cuts the level of interest rates in nominal terms. For instance, interest rates

Source: Bloomberg

Graph 1ECB reference interest rates in the market and yields on bonds of selected countries, %, and Eurosystem’s assets, in EUR billion, 2006-2015

20


on three-month debt of majority euro area countries were negative at end-2015, including periphery countries, except Greece. Interest rates on two-year debt of Italy, Spain and Portugal were around zero, while they were negative on German and French debts. Finally, interest rates on the ten-year debt of Germany, France, Italy, Spain and Portugal were only -0.3%, 1%, 1.6%, 1.8% and 2.5%, respectively, which was extremely low, taking into consideration the public debt levels of majority of these coun-tries and overall economic situation and expectations. Simultaneously, compared to the debt crisis in the euro area, a significant convergence between interest rates is currently evident, without major differences between core and periphery countries.

Expectations for 2016 and potential effects of international environment on Montenegro

The IMF forecasted growth of the global economy at higher rates in the period 2016 – 2017, whereby these growth forecasts have been already declined. The global economy growth forecast amounted to 3.4% for 2016 and also for the volume of global trade.

Advanced economies will grow at a rate of 2.1%. in 2016. As for the largest euro area economies, only the forecast for Spain is lower compared 2015. Emerging/developing economies will grow at a rate of 4.3%, according to the IMF forecast, which 0.3 percentage points more compared to 2015. With regard to the BRIC countries, the Chinese economy will slow down, while the Russian economy will experience a substantially smaller decline and it should have a positive growth rate in 2017. As for European emerging and developing economies, the IMF forecasted growth of this region of 3.1% (0.3 percentage points lower than in 2015), which represents a relatively modest growth rate. Forecasts for economies in Montenegro’s immediate environment, which should achieve relatively good results in the following two years, are encouraging.

The most important impact of international environment on Montenegro is capital flows, whether these are foreign direct investment or other forms of foreign investments - portfolio and other inves-tments, since the growth of Montenegrin economy is still primarily caused by the inflow of foreign investments. Based on this criteria, the most important economic partners are Russia and EU/euro area. To that end, still relatively weak growth of the EU/euro area countries (in relation to, for exam-ple, USA), and instabilities in Russia (the IMF expects a decline in economic activity of 3.7% in 2015) pose relative threat. In particular, geopolitical tensions and situation in Ukraine should be mentioned here as well. However, there were no negative developments in 2015 in this area, and net FDI inflow increased 75% y-o-y. FDIs from Russia declined by 43.8% after a decline of 10% in 2014 compared to 2013, and Russia ranked third in 2015 among investor countries in Montenegro. However, the largest amount of investments in real estates came from Russia in 2015, closely to 54 million euros. As for portfolio investments, 500 million euros was gathered based on the issue of Government Eurobonds in 2015 (with the lowest interest rate in relation to all previous issues of Eurobonds), and a net inflow of foreign portfolio investments was 32.8% higher than in 2014.

Ukraine crisis did not have much effect on tourist overnights and arrivals, since arrivals of both Russi-an and Ukraine tourists declined y-o-y (-6.3% and -10.6%, respectively), while overnights of Russian tourists increased and that of Ukraine tourists slightly declined (6.3% and -0.3%, respectively). With

21


regard to the number of tourists from Serbia, an extraordinary growth of both arrivals (29.7%) and overnights (39%) was reported over the one-year period partially due to the low base effect.

As for the exchange rates, the most important for Montenegrin economy are the Euro-U.S. dollar and partially (specifically) the Euro-Swiss Franc exchange rates. A stronger Euro against the U.S. dollar enables a decline in fuel prices while, on the other hand, it brings lower revenues to aluminium indu-stry. With regard to the banks’ balance sheets, the U.S. dollar is the most represented second foreign currency compared to Euro both on the assets and liabilities and the capital side, amounting to some 155 million euros at end-2015. However, the positions are well balanced and funds in U.S. dollars were mostly placed at deposit accounts abroad, thus no danger should be present in this area for Montene-grin banks. In addition, the effect of the EUR-USD exchange rate was a relatively important factor for the Government debt and guarantees to the extent in which the hedging against exchange rate was not contracted. The share of debt in other foreign currencies (including SDR and not excluding the SDR portion in euros) in total Government debt was 12% at end-September 2015, of which the largest porti-on referred to USD, and there was a significant portion of dollar loans guaranteed by the Government (almost 90 million euros at end-September 2015). Weakening of Euro compared to U.S. dollar in this context would have a negative effect on public finances. Finally, with regard to the EUR-CHF currency pair, one bank had exposure in CHF in the amount of about 21 million euros at end-2015, mostly in lo-ans to citizens - residents. Although this bank hedged against foreign exchange rate risk by balancing the position on the liabilities and capital side, it could not avoid credit risk and it had/has significant problems in collecting these loans. Any weakening of EUR against CHF exerts a pressure on debtors, i.e. bank’s exposures and the situation particularly worsened when the Swiss National Bank announ-ced abandoning the ceiling of already strong Franc in mid-January 2015. The situation in Montenegro changed somehow with the adoption of the Law on the Conversion of Swiss Franc (CHF)-denomina-ted loans into Euro (EUR)-denominated loans at end-July 2015 aimed at protecting the debtors of this bank. The Law envisages the conversion of debt into EUR the day when the loan agreement was made and a new calculation of loans by applying a flat interest rate of 8.2%. (Simultaneously, the imple-mentation of the Law will not lead to a decline in the solvency ratio of this bank below the regulatory minimum).6

With regard to the Greek crisis, it is difficult to say at this moment what the situation will be and what would be the effects of potential new negative developments. Concerning direct impacts on Montene-gro, they should not be significant, since there are no Greek banks in Montenegro’s market, our banks are not connected with Greek banks and they are not exposed to other Greek entities, the import in Greece is small as is FDI inflow from Greece. However, potential indirect effects are possible throu-gh the crisis effect on overall situation in the euro area/EU, i.e. in global financial markets. There is a potential increase in return on government debt of the euro area periphery countries, which could result in expensive borrowing of Montenegro in the following period. Generally speaking, risk premi-um could increase with regard to any type of foreign investments to Montenegro. Also, certain Euro depreciation against U.S. dollar is possible (and other global currencies), which could not seriously jeopardise the Montenegrin economy since EUR is the most represented currency in all important segments of the economy both in its flows and conditions. Finally, certain transfer of foreign tourists from Greece to Montenegro is likely to happen, if deepening of the crisis would result in social unrest in Greece and other difficulties (fuel and/or food and other groceries shortages, lack of cash in banks, worsening of the refugees situation, and the like) that would be substantially strong so that tourists

6 OGM 46/2015

22


perceive Greece as an unstable country. Currently, negative indirect effects of the Greek crisis practi-cally are not felt by the Montenegrin economy.

It is very important to mention the ECB monetary policy, which additionally cut its interest rates to historically minimum levels. The ECB Governing Council decided, at its meeting held at the beginning of December 2015, to additionally lower interest rate on overnight deposits of banks held with the Eu-rosystem from -0.2% to -0.3%, while the interest rate on overnight loans of the Eurosystem to banks and the interest rate on main refinancing operations remained at 0.3% and 0.05%, respectively. Also, this has been an ongoing trend of lowering the ECB interest rates, which started at the end of 2008.

This represents the possibility for Montenegro and also a danger for further accumulation of certain risks. With regard to foreign borrowings of banks (from parent/related or other banks), it had a decli-ning trend in the previous years. Although borrowings were stable in 2015, relatively speaking, it sli-ghtly declined in 2015 as well, making up only 7.5% of total banks’ liabilities and capital at the end of the year. This ongoing decline was a result of several factors: 1) deleveraging strategy, i.e. a decline in exposure of parent banks to its subsidiaries due to problems faced by parent banks in parent markets, 2) stabilisation and growth in deposit base of domestic banks and the related change in the approach of domestic banks to finance more through domestic deposits and less through foreign borrowings, and 3) the losing of momentum in the Montenegrin economy and the related loss of attractive inves-tment possibilities for domestic banks, together with a decline in demand for loans with certain enti-ties. Moreover, as for the banks’ borrowings, risks are currently under control.

On the other hand, government foreign borrowing remains a concern. It increased in the post-crisis period as a result of several factors, thus external debt at end-September 2015 amounted to 54.9% of GDP. With regard to the structure, Eurobonds accounted for the main share, based on which debt increased by 966.6 million euros (26.9% of GDP), which is almost half of the amount of external debt, while the remaining portion of the external debt referred to bilateral credit arrangements. In addition, the increase in debt based on Eurobonds resulted in growth in total government external debt. Higher borrowing was possible since foreign central banks (primarily the ECB but also the FED) maintained expansive monetary policy and created a substantial amount of additional liquidity which the banks did not want to transfer to the private sector, and on the other hand, Montenegro s indebtedness at the beginning of this period was relatively low. However, currently, indebtedness has grown increasingly while fiscal deficits in the post-crisis period remain a structural problem since the economy has solid growth, and certain fiscal deficits are still being recorded. On the other hand, it is unreasonable to expect that the euro interest rates would soon return to normal levels, which is attractive for indebted-ness.

Positive side of extremely low Euro interest rates reflected in the possibility of refinancing of the exi-sting debt (Eurobonds and the remaining portion of external debt) at low interest rates, which would influence the decline of interest expenditures in future, thereby indirectly influencing the space for decline in the balance (principal) of debt. However, new borrowings which would not be used just for refinancing, but which would additionally increase the balance (principal) of debt, would represent a dangerous accumulation of risks and extreme vulnerability in the situation when euro interest rates start returning to their normal levels.

23

Macroeconom

ic Developm

ents in the Country

2. MACROECONOMIC DEVELOPMENTS IN THE COUNTRY

2.1. Economic Activity Developments

Economic growth in Montenegro showed stronger signs of recovery in 2015 compared to the previous period. Almost all indicators measuring economic activity in the country recorded relatively strong annual growths, thereby contributing to a positive rate of total real growth of 3.2%7. Manufacturing industry, tourism, and construction sectors affected positively such estimated growth rate. The decline in output reported in the electricity, gas and steam supply sector of 5.9% and that in the mining and quarrying sector of 8.1% had a negative impact.

Table 2.1

Selected industries’ trend, 2015/2014, %

Retail trade, turnover (constant prices) 2,2

Tourism

Number of arrivals 12,9

Number of overnights 15,7

Manufacturing industry, physical volume 19,9

Construction

Value of completed works 5,8

Effective working hours 4,7

Electricity, gas and steam supply -5,9

Mining and quarrying, physical volume -8,1

Forestry, physical volume (index weighted) 17,6

Source: Monstat

Monstat s final data showed real growth in Montenegro’s GDP of 1.8% in 2014, while the preliminary data for Q1, Q2, Q3 and Q4 2015 showed real growth of 3%, 3.7%, 4.2%, and 1.4%, respectively.

7 Monstat preliminary data.

24


Labour market developments did not have a consistent trend. The reporting year was characterised by growth both in the number of employed (1.2%) and registered unemployed persons (3.9%). A sli-ght increase in gross and net wages and salaries was recorded in 2015 of 0.27% and 0.6% respectively, which was still not sufficient for stronger recovery of aggregate demand. However, simultaneously reduced pressure of labour factors contributed to the preservation of the corporate sector s competi-tiveness.

The unemployment rate was still very high. According to the Employment Agency data, the unem-ployment rate in December amounted to 17.24% and it increased 2.29 percentage point y-o-y. Accor-ding to the Monstat s Labour Force Survey, the unemployment rate amounted to 17.6% in 2015.

As compared to the neighbouring countries which also faced high unemployment, Montenegro has a medium score, which certainly does not diminish the need to undertake activities to reduce unem-ployment rate and resolve structural problems in the economy.

Table 2.2

Basic labour market indicators (annual average)

2014 2015 Change (2015/2014), %

Employed 173,595 175,617 1.2

Unemployed 33,284 34,587 3.9

Wages, gross, EUR 723 725 0.27

Wages, net, EUR 477 480 0.6

Sources: Monstat, Employment Agency

Table 2.3

Unemployment in the regional countries, Labour Force Survey, %

Country Unemployment rates, 2015

Slovenia 9,0

Croatia 16,6

Serbia 17,0

Montenegro 17,6

Macedonia 27,0

Bosnia and Herzegovina 27,7

Source: WIIW, March 2016; for Montenegro - Monstat

Reduced liquidity and insufficient recovery of the real sector were still present in 2015. The enforced collection indicators pointed to the problem of the corporate sector liquidity. As at 31.12.2015, 14,870 debtors had their accounts frozen, which was the y-o-y increase of 5%. As for the value of these acco-unts, the total amount of debt based on which the accounts were frozen amounted to 548,021,273.62 euros, which was a y-o-y increase of 10.5%. On the other hand, the share of persons whose accounts were frozen declined and stood at 19.3%, i.e. 2.5 percentage points less than at end-2014.

25

Macroeconom

ic Developm

ents in the Country

It is worth mentioning that debt concentration was relatively high at the year-end. Thus, 10 largest debtors or 0.07% of total number of recorded debtors accounted for 12.25% in the total amount of fro-zen funds, which means that the amount of their frozen funds was 67,159,234.05 euros.

Fifty largest debtors comprising 0.34% of total recorded debtors accounted for 35.36% in total amount of frozen funds, which means that the amount of their frozen funds was 193,804,256.39 euros.

Table 2.4

Basic statistics of enforced collection, end of the period

2014 2015 Change, %

Number of persons with frozen accounts 14,160 14,870 5.0

As % of total number of persons 21.8 19.3 (percentage points) -2.5

entities with uninterruptedly frozen accounts up to one year, EUR 58,394,100.19 38,756,790.53 -33.6

entities with uninterruptedly frozen accounts over one year, EUR 437,717,022.82 509,264,483.09 16.3

Total, EUR 496,111,123.01 548,021,273.62 10.5

Source: CBCG

Forecast of GDP trends in 2016 and impact on financial stability

Real growth in 2016 will depend on a number of factors influencing the intensity and level of recovery. The most important variables that are expected to affect a high inflow of foreign capital are the conti-nuance of work on a large number of initiated investment projects in tourism, energy sector and public sector (highway construction) and the dynamic for realisation of the announced investment projects in 2016. Capital inflow was the main driver of the economy in the last several years. The level of FDI inflows in developing countries and Montenegro will depend on the situation in the international market and the willingness of foreign investors to invest (to lend money).

The highway construction has a dual impact on the situation of economic activity and the level of ri-sks in Montenegro. This capital and one-off investment will affect growth of economic activity whilst affecting an increase in the public debt and pressures in the fiscal sector. When implementing such important infrastructure projects, it is very important that the development component enables public debt sustainability.

When it comes to the contribution of the banking sector to GDP growth, it should be borne in mind still present problems of high interest rates and a relatively high level of non-performing loans alt-hough both indicators trended down during 2015. Banks are still cautious when granting new loans. However, an increasing trend in new loans indicated the improvement of the situation and change in banks’ expectations regarding the situation in the economy from the position of new risk taking. Further decline in non-performing loans is expected as is a gradual decline in interest rates which would positively affect a further decline in new loans and a sound financing of the real recovery. The entrance of new banks in the market and higher competition should encourage such trends.

26


According to the foreign institutions’ forecasts shown in Table 2.5, the growth rate is expected of 3.75% (the rate is obtained as a simple average of forecasts of GDP growth by international institutions from the same Table).

Table 2.5

Forecasts of international institutions on Montenegro’s GDP trending in 2016 (in %)

Institution Estimated growth rate for 2016

IMF 4.7*

EBRD 4.0

UN Department for Economic and Social Affairs 3.3

European Commission 4.0

Vienna Institute 2.8

World Bank 3.7

* IMF, World Economic Outlook Database April 2016 Source: Web sites of individual institutions

Box 2.1 - GDP per capita and actual individual spending according to the purchasing power parity

Noticeable differences in GDP per capita and actual individual spending at purchasing power parity (PPP) have been present among the EU member states and EU candidate countries.

GDP per capita at PPP is an indicator that eliminates differences in prices between peer countries and it is more realistic indicator of differences regarding the degree of economic development compared to GDP per capita in terms of current prices. Ac-cording to Eurostat and peer coun-tries, the value of index for Montene-gro is 41. This means that the living standard in Montenegro is more than half the EU average. However, the liv-ing standard in Montenegro is only 14 points below the average of the former Yugoslav countries and only Slovenia and Croatia are in front of Montenegro as EU member states.

Table 1

GDP per capita at PPP, EU 28 = 100, 2014

Country Index

Albania 30

Bosnia and Herzegovina 29

Bulgaria 47

Montenegro 41

France 107

Greece 73

Croatia 59

Italy 96

Macedonia 37

Germany 124

Romania 55

Slovenia 83

Spain 91

Serbia 37

UK 109

EX YU 48

USA 148

Japan 100

Source: Eurostat, CBCG calculations

27

Macroeconom

ic Developm

ents in the Country

The IMF data, which were calculated compared to the U.S. economy as the benchmark economy, showed that the position of all major economies was worse than that of the USA in terms of GDP per capita at PPP. Meas-ured by this indicator, even besides strong convergence that occurred in the last several years and decades, the living standard in China and India is currently four and nine times lower than in the USA, respectively. German economy is closest to the USA, and German GDP per capita at PPP was 16 points lower than the American. Based on the same data, the living standard in Montenegro was three and a half times lower than in the USA or some-what below the average standard of the former Yugoslav countries.

However, it is considered that the ac-tual individual consumption is even better indicator of the living standard of households than GDP per capita. Actual individual consumption indi-cates actual consumption of goods and services by households, including situations when such a consumption is funded by the state or non-profit or-ganisations, which varies by the coun-try, particularly in the case of health services or education services. The Eurostat data (EU 28 = 100) showed 52 points for Montenegro, which is much better compared to to the GDP per capita. Simultaneously, Montenegro is at the average level of the former Yu-goslav countries, based on the actual individual consumption.

Table 2

GDP per capita at PPP, USA = 100, 2015 (estimate)

Country Index

Albania 21


Bulgaria 33

Montenegro 28France 74

Greece 46

Croatia 38

India 11

Italy 64

Japan 68

China 25

Macedonia 25

Germany 84

Romania 37

Russia 42

Slovenia 55

Spain 63

Serbia 24

UK 73

EX YU 31

Source: IMF, CBCG calculations

Table 3

Actual individual consumption per capita at PPP, EU 28 = 100, 2014

Country Index

Albania 37


Bulgaria 51

Montenegro 52France 112

Greece 83

Croatia 60

Italy 98

Macedonia 40

Germany 123

Romania 57

Slovenia 75

Spain 88

Serbia 47

UK 115

EX YU 52


28


Table 2.6

Montenegro: Selected economic indicators, 2010-2016 (Forecasts with assumption of current economic policies also applying in the future period)

Real economy 2011 2012 2013 20142015 2016

estimate forecast

Nominal GDP (in million euros) 3.265 3.181 3.362 3.458 3.641 3.840

Gross national savings (as percentage of GDP) 1,8 2,1 5,1 4,6 14,6 10,0

Gross investments (as percentage of GDP) 19,3 20,6 19,6 19,8 28,0 28,6

Change in percentages

Real GDP 3,2 -2,7 3,5 1,8 4,1 4,6

Industrial output -10,3 -7,1 10,6 -11,5 13,7 ...

Tourism

Arrivals 8,7 4,8 3,7 1,7 12,7 ...

Overnights 10,2 4,3 2,8 1,5 15,6 ...

CPI (annual average) 3,1 3,6 2,2 -0,7 1,6 0,9

CPI (period end) 2,8 5,1 0,3 -0,3 1,4 1,4

GDP deflator 1,2 0,2 2,1 1,0 1,2 0,8

Average net salary (12 month average)1 1,0 0,7 -1,7 -0,5 0,4 ...

Cash and loans (period end, change in %)

Loans to private sector2 -13,0 -3,1 2,1 -0,4 2,3 2,7

Corporates -20,3 -4,9 0,4 -2,8 2,2 ...

Households -3,2 -1,1 3,7 1,7 2,7 ...

Private sector deposits 1,2 7,2 1,3 6,1 9,0 ...

General Government finances, based on accrual accounting3 as percentage of GDP

Revenues and grants 38,5 39,9 41,3 43,5 40,6 42,2

Expenditures 45,3 45,7 47,6 46,1 48,0 51,4

Deficit/surplus -6,7 -5,8 -6,3 -2,6 -7,4 -9,2

Primary deficit/surplus -5,3 -4,0 -4,2 -0,3 -4,9 -6,8

Domestic financing (net) 2,5 -0,6 1,4 -0,6 -1,8 1,8

Privatisation proceeds 0,2 0,2 0,8 0,3 0,3 0,1

Gross General Government debt 45,6 53,4 55,2 59,9 66,5 70,5

General Government debt and issued guarantees 57,2 65,4 64,2 69,0 80,8 84,1

Balance of payments

Current account balance -17,6 -18,5 -14,5 -15,2 -13,3 -18,6

Foreign direct investments 11,9 14,5 9,6 10,2 15,7 12,0

External debt (stock at end of period) 145,0 155,9 151,5 154,8 152,1 154,8

Of which: private sector4 112,4 115,2 111,3 109,6 94,8 93,3

Real effective exchange rate (based on CPI; average % change)

(minus refers to depreciations) -3, 2 3,2 0,8 -2,0 ... ...

Additionally:

Nominal GDP growth (in percentages) 4,5 -2,6 5,7 2,8 5,3 5,5

Deficit/surplus without highway construction project (as percentage of GDP) -6,7 -5,8 -6,3 -2,6 -2,9 -1,2

Aluminium price (in euro per tonne) 1.822 1.542 1.348 1.514 1.549 1.391

1 Including a change in the MONSTAT methodology, starting from 1 January 2010;2 Changes in classification of off-balance sheet items created a break in structure in 2012; annual change in credit growth

in 2013 cannot be compared due to the change in methodology;3 Data includes state funds and municipalities, but not the state owned companies;4 Assessments, because private debt statistics is not published;

Source: Taken from the IMF Mission Report within the consultations pursuant to Article IV of the IMF Articles of Agreement, March 2016 (Original source: MF, CBCG, Monstat, Employment Agency, IMF’s forecasts and assessments)

29

Macroeconom

ic Developm

ents in the Country

Table 2.7

Montenegro: Selected economic indicators, 2014-2017

Indicator 20142015 2016 2017

Forecasts

Real GDP growth 1,8 3,9 4,0 4,1

Unemployment rate (as % of total labour force) 18,2 17,6 17,2 16,8

Consumer prices index, % -0,5 1,5 1,9 2,2

Current account deficit (% of GDP) -15,2 -12,9 -13,4 -13,9

Fiscal deficit (% of GDP) -2,8 -7,0 -6,6 -6,1

Public debt (% of GDP) 54,8 61,4 65,8 68,9


Table 2.8

Real growth of GDP, EBRD projections, %

Country/Region 2014Projection, November 2015 Projection, May 2015

2015 2016 2016 Change May - Nov

Central Europe and Baltic Countries

Croatia -0,4 0,9 0,5 0,5 0,0

Estonia 2,9 2,0 2,8 3,0 -0,2

Hungary 3,7 2,9 2,1 2,3 -0,2

Latvia 2,4 2,3 3,1 3,1 0,0

Lithuania 3,0 1,7 3,0 3,2 -0,2

Poland 3,3 3,4 3,3 3,4 -0,1

Slovakia 2,5 3,1 3,2 3,3 -0,1

Slovenia 3,0 2,3 2,0 2,3 -0,3

Average 3,1 3,0 2,9 3,0 -0,1

South-eastern Europe

Albania 2,2 2,3 3,3 3,0 0,3

Bosnia and Herzegovina 1,0 2,8 3,0 3,0 0,0

Bulgaria 1,5 1,8 2,0 1,5 0,5

Cyprus -2,5 1,0 1,7 1,5 0,2

Macedonia 3,5 3,5 3,5 3,7 -0,2

Greece 0,7 -1,5 -2,4 2,0 -4,4

Kosovo 0,9 2,0 3,0 3,5 -0,5

Montenegro 1,8 3,0 4,0 3,7 0,3

Romania 2,8 3,5 3,7 3,2 0,5

Serbia -1,8 0,5 1,8 1,8 0,0

Average 1,4 1,6 1,6 2,5 -0,5

30


According to the model-based CBCG projections in 2016, GDP growth will range from 3.8% to 4.2%, with the central projection of about 4%. For testing the central projection of GDP, a GDP estimate using the expenditure method was also done. Starting assumptions for the calculation using the ex-penditure method include:

• Growth of the household spending of 2.7% due to an increase in wages and salaries and certain new employment, caused by the strengthening of investment activity, increase in pensions, and increase in lending activity of banks, mild decline in lending interest rates due to larger market pressures;

• Government spending growth up to 2.5% as a result of the announced increase in wages and salaries in the public sector and pensions;

• Growth in investments in fixed assets of 15.5% as a result of capital investments in the con-struction of the Smokovac-Mateševo highway section and foreign direct investments in the area of tourism (Portonovi, Luštica, bay of Pržno near Tivat and Mamula) and energy (con-struction of submarine cable between Italy and Montenegro and wind power plant at Možura);

• Export of goods and services will grow at a rate of 1%, as a consequence of projected lower con-sumption by foreign tourists compared to the record 2015, and also weak external demand for goods, particularly for metals;

• Imports will show growth of 3.5% because of investors’ need to import equipment, constructi-on material, and labour force, especially for the highway construction, and the substitution of the import of food by domestic production will have a negative effect on imports growth.

According to the expenditure method, GDP will grow at a rate of 4% in 2016, which indicates the vali-dity of the central projection of the GDP growth.

Simple average of the real GDP growth estimates by international institutions shows that the Monte-negrin GDP growth in 2016 should be at the level of 3.75% (Table 2.5).

2.2. Inflation

Monthly inflation rate in December 2015 amou-nted to -0.3%, while the consumer prices increa-sed by 1.4% y-o-y. The average annual CPI inflati-on amounted to 1.5% which was higher than the average annual inflation in EU (0.0%).

The largest inflation drivers in 2015 was growth in the prices under food and non-alcoholic beve-rages (2.4%), housing, water, electricity, gas and other fuels (1.6%), clothing and footwear (5.0%), health care (1.6%), alcoholic beverages and to-bacco (3.3%) and hotels and restaurants(3.4%) ca-tegories.

Consumer prices, annual growth rate (%) 2014-2015

Graph 2.1

Source: Monstat

31

Macroeconom

ic Developm

ents in the Country

Table 2.9

Share of trends of individual categories of products in total inflation

Weight Growth rate XII 15/XII 14

Share, percentage points

TOTAL 1.000 1.4 1.4

Food and non-alcoholic beverages 386.4 2.4 0.93

Alcoholic beverages and tobacco 37.9 3.3 0.13

Clothing and footwear 70.7 5.0 0.35

Housing, water, electricity gas and other fuels, 153.1 1.6 0.24

Furnishing, household equipment and routine household maintenance 46.9 1.1 0.05

Health care 38.2 1.6 0.06

Transport 101.0 -4.6 -0.46

Communications 57.1 0.1 0.01

Recreation and culture 27.2 0.5 0.01

Education 15.7 0.0 0.0

Hotels and restaurants 23.0 3.4 0.08

Other products and services 42.8 0.5 0.02

Source: Monstat and CBCG calculations

According to the harmonised consumer prices index (HCPI) (methodological standard in the EU/euro area, which differs somewhat from the consumer prices index (CPI)), the annual inflation rate in Mon-tenegro amounted to 1.7% in December 2015. The average annual growth rate according to the HCPI amounted to 1.4%.8

Table 2.10

CPI (HCPI) of the selected countries, %8

XII 12/XII 11 XII 13/XII 12 XII 14/XII 13 III 15/III 14 VI 15/VI 14 IX 15/IX 14 XII 15/XII 14

Albania 2.4 1.9 0.7 2.2 1.4 2.2 2.0

BiH 1.8 -1.2 -0.4 -0.2 -0.5 -1.8 -1.3

Montenegro 5.1 0.3 -0.3 1.6 1.9 1.7 1.4

EMU 2.2 0.8 -0.2 -0.1 0.2 -0.1 0.2

EU 2.3 1.0 -0.1 -0.1 0.1 -0.1 0.2

Croatia 4.4 0.5 -0.1 0.0 0.1 -0.5 -0.3

Macedonia 4.7 1.4 -0.5 -0.3 0.5 -0.2 -0.3

Slovenia 3.1 0.9 -0.1 -0.4 -0.9 -1.0 -0.6

Source: Statistical offices of the selected countries, Eurostat

8 CPI for non-EU countries (Albania, Bosnia and Herzegovina, Montenegro and Macedonia), i.e. HCPI for the EU member states.

32


In addition to the quantitative easing measures and maintaining stimulative monetary policy, the inflation in euro area and the EU remained low and at 0.2%. With a view to achieving targe-ted level of inflation below but close to 2%, quan-titative easing measures are still carried out.

Weights of 38.6% for CPI and 31.7% for HCPI make the food the most important category/factor in the total inflation in Montenegro. In the euro area, in accordance with the average household spending and its spending for food and non-alcoholic beve-rages, the same weight amounted to 15.6%, which indicated to substantially lower effect of global changes in food prices on general inflation relative to to the situation in Montenegro.

The IMF estimates show a further decline in the prices of oil and other energy generated products also in 2016.

Based on the last projections for the IMF Mission Report within the consultations pursuant to Article IV of the IMF Articles of Agreement, the IMF estimated that the inflation rates in Montenegro would be positive in the following medium-term period. Annual inflation in the period 2016-2020 will amo-unt to 1.4%, 1.4%, 1.6%, 1.7%, and 1.8%, respectively.

General inflation trend and trend of food commodities inflation in Montenegro and the

euro area; HIPC, %, annual rate, 2014-2015

Graph 2.2

Source: Monstat, Eurostat

CPI projections of Montenegro for 2016

Graph 2.3

Source: CBCG, 2016

33

Macroeconom

ic Developm

ents in the Country

Inflation fan chart of Montenegro, based on the ARIMA model assessment for 2016, shows 90% proba-bility of inflation measured by the consumer prices index, depending on the month, which will range in the interval from 0.7% to 2.8%, whereas the projected inflation for end-2016 will vary from 1.9% to 2.8%. Namely, as the time span for forecasting increases, uncertainty increases, as does the forecast span. The central projection of the fan chart (which refers to the darkest part of growth) shows the probability span of 10%. The central projection of the model shows that an average inflation in 2016 will be 1.6%.

Starting assumptions for the inflation forecast for 2016 include:

1. Growth in investments and more intensive economic activity in 2016;2. A 5% increase of electricity price (planned increase of prices in August 2016 included);3. Real wages and salaries will increase in 2016 as compared to 2015;4. Real estate prices stagnation5. Mild decline in oil and natural gas prices;6. Unfavourable weather in the country and the region could result in a more pronounced

growth in the food commodities prices.

Any deviation in some of the said assumptions would require correction of the forecast.

Box 2.2 - Prices and consumption disparities

Significant price disparities exist among the EU member states and candidate countries. Generally, in accordance with the economic development level and nominal wages and salaries, prices are higher in developed countries relative to less developed countries. Observed by groups of products, the con-vergence is higher with tradable commodities and lower with less tradable commodities and services. According to the Eurostat statistics, goods and services in Montenegro are half the prices compared to the EU average; to be more precise, 45% of the EU average prices, which is, generally observed, at the level of the average of the former Yugoslav countries (except Kosovo). According to the group of products, clothing in Montenegro is only 7% cheaper, equipment for personal transport by 14%, and household appliances by 18%, while electronic devices and footwear were more expensive than in the EU, by 1% and 7%, respectively.

34


Table 1

Prices of individual groups of products by countries, EU 28 = 100, 2014

Group of products AL BiH BU MN FR GR CRO IT HU GER RUS SL ES SRB UK EX YU

Food and non-alcoholic beverages 69 76 70 76 110 103 92 110 59 104 68 96 93 70 104 78

Alcoholic beverages and tobacco 50 47 57 58 106 91 71 96 37 93 70 81 87 50 166 57

Clothing 66 85 80 93 102 89 86 104 76 101 86 94 85 92 103 88

Footwear 74 81 73 107 104 93 83 108 80 105 96 87 91 92 95 88

Electricity, gas and other fuels 60 47 51 54 94 100 67 119 48 121 55 88 111 42 96 58

Furniture and furnishings 53 58 51 66 95 101 76 113 61 94 69 79 103 65 118 68

Household appliances 82 67 67 82 106 89 90 103 62 99 77 94 99 79 113 79

Electronic devices 112 98 95 101 100 100 106 97 89 96 108 103 95 93 109 98

Personal transport equipment 79 83 82 86 102 91 87 98 85 97 85 87 102 83 103 85

Transport services 34 69 48 53 106 76 78 71 40 118 47 95 81 56 134 65

Communications 52 80 69 72 97 139 72 118 61 103 56 90 107 54 125 72

Restaurants and hotels 42 57 44 60 109 81 76 109 42 98 52 85 88 50 114 62

Total 48 52 48 55 108 85 66 103 47 101 53 82 92 50 121 59


Disparities are very pronounced in specific groups of products and services in total households con-sumption. In general, households in developed countries spend more on furniture and services (in percentage terms) and less on food, as opposed to less developed countries. As for the EU countries compared to the candidate countries (except Turkey), households spend more from their budgets on housing, water and electricity (24.4% compared to 18.9%), transport (13% compared to 9.6%), recrea-tion and culture (8.6% compared to 6.4%) and in particular on restaurants and hotels (8.2% compared to only 2.9%). On the other hand, households in the candidate countries spend on food and non-al-coholic beverages 32.9% of their budgets as compared to the EU where they spend only 12.3%. Com-pared to the candidate countries’ average, households in Montenegro, spend more on clothing and footwear (8.3% compared to 5% of the budget), and less on recreation and culture or housing, water and electricity (3.6% compared to 6.4% or 14.5% compared to 18.9% of the budget, respectively).

35

Macroeconom

ic Developm

ents in the Country

Table 2

Households’ consumption by countries and groups of products, %, 2014

Group of products AL BU MN FR GR IT HU GER RUS SL ES SRB UK EU (28)

EU candidate

Food and non-alcoholic beverages 39.0 18.7 34.2 13.4 16.8 14.2 32.8 10.2 29.7 15.0 13.0 25.7 8.6 12.3 32.9

Alcoholic beverages and tobacco 3.1 6.7 3.8 3.5 4.9 4.2 5.6 3.3 5.4 5.6 4.0 6.9 4.0 4.0 4.9

Clothing and footwear 4.1 3.1 8.3 4.2 3.4 6.1 4.3 4.9 3.4 5.2 4.4 3.3 5.7 5.0 5.0

Housing, water, electricity 13.0 18.8 14.5 26.7 21.1 24.4 25.8 24.3 21.4 18.6 23.8 22.1 24.3 24.4 18.9

Furniture, furnishings and household maintenance 6.1 6.4 4.0 5.3 3.3 6.1 3.0 6.7 4.4 5.3 4.1 3.8 4.7 5.4 4.2

Health 4.9 4.9 3.9 4.3 4.1 3.3 1.5 5.4 6.0 4.0 4.2 4.2 1.8 3.9 3.6

Transport 5.4 15.4 11.5 13.0 13.6 12.0 8.9 14.2 11.3 16.2 11.5 12.6 14.1 13.0 9.6

Communications 1.9 5.6 4.9 2.6 3.5 2.3 3.9 2.7 4.2 3.3 2.6 4.6 2.0 2.5 3.8

Recreation and culture 12.8 7.0 3.6 8.2 4.9 6.6 3.0 9.5 6.1 8.6 6.8 6.2 10.0 8.6 6.4

Education 2.9 0.9 2.8 0.9 2.3 1.0 1.4 0.8 2.1 1.3 1.8 1.3 1.8 1.2 2.1

Restaurants and hotels 2.8 7.0 3.0 6.5 14.5 9.7 3.4 5.3 2.1 7.0 14.5 2.2 9.6 8.2 2.9

Other goods and services 4.1 5.6 5.5 11.5 7.6 10.0 6.4 12.8 4.0 9.9 9.3 7.1 13.3 11.5 5.8

Albania, France, Macedonia - 2013, Romania - 2012


2.3. Fiscal Deficit/Surplus

Fiscal consolidation remained the priority of Montenegro s fiscal policy in 2015. However, budget pro-jections were not met in the volume and according to the dynamics as it was planned. Thus, a down-trend in negative balance of the budget continued also in 2015. Montenegrin budget recorded a level of deficit higher than that planned, primarily due to the repayment of obligations from the previous period and capital expenditure in the current budget.

Table 2.11

Fiscal deficit/surplus trend - latest data

Description/ Period 2011 2012 2013 2014 Assessment2015

Projection2016

Source revenues, in million euros 1.133,2 1.126,1 1.243,4 1.353,6 1.326,7 1.458,5

Expenditures, in million euros 1.318,8 1.333,9 1.459,2 1.460,7 1.618,0 1.732,4

Deficit/surplus, in million euros -185,7 -207,8 -215,8 -107,1 -291,3 -273,9

Deficit/surplus, as % of share in GDP -5,6 -6,5 -6,4 -3,1 -8,1 -7,2

Source: 2011-2014 – laws on budget execution, 2015-2016 - MF (GDDS tables)

36


Source revenues of the budget amounted to 1.33 billion euros or 36.9% of the estimated GDP9. The-se revenues declined by 0.2% compared to the plan. The decline in revenues resulted from the lower collection of taxes than planned mostly due to lower collection of VAT revenues (-23.1 million euros or 4.8%), corporate income tax (-4.5% million euros or 9.6%) and personal income tax (-3.2 million euros or 2.9%). Source revenues declined by 2% compared to 2014.

The most important year-on-year increase in revenues was recorded in the collection of excise duties that amounted to 170 million euros, which represented a growth of 8.7% or 13.5 million euros. Incre-ase in these revenues resulted from the increase in excise duties on tobacco pursuant to the „excise calendar“, which was in the function of harmonisation of domestic regulation with the EU regulations.

The Ministry of Finance estimated that total budget proceeds (source revenues and additional fun-ding) in 2015 amounted to 2.17 billion euros or 60.3% of the estimated GDP.

Table 2.12

Budget revenues in 2015 and comparison with 2014

Type of revenueOutturn Plan

Difference relative to the plan

2014Difference relative

to 2014

mil. € mil. € mil. € % mil. € mil. € %

BUDGET REVENUES 1,326.7 1,329.2 -2.5 -0.2 1.353.7 -27.0 -2.0

Taxes 805.5 832.7 -27.1 -3.3 833.2 -27.7 -3.3

Personal income tax 104.8 107.9 -3.1 -2.9 104.4 0.4 0.3

corporate income tax 42.2 46.6 -4.4 -9.4 45.0 -2.9 -6.4

Tax on immovable property transactions 1.5 1.6 -0.1 -6.3 1.5 0.0 0.5

Value added tax 457.1 480.2 -23.1 -4.8 497.6 -40.5 -8.1

excise duties 170.0 167.7 2.3 1.4 156.5 13.5 8.7

Tax on international trade and transactions 22.9 22.9 0.0 0.0 22.3 0.6 2.8

Other taxes of the Republic 7.1 5.7 1.4 24.6 6.0 1.2 19.2

Contributions 437.3 417.5 19.8 4.7 444.3 -7.0 -1.6

Contributions for pension and disability insurance 264.1 246.4 17.7 7.2 270.1 -6.0 -2.2

Contributions for health insurance 150.3 145.5 4.8 3.3 151.0 -0.7 -0.5

Contributions for unemployment insurance 12.1 12.7 -0.6 -4.7 12.2 -0.1 -0.4

Other contributions 10.8 12.9 -2.1 -16.3 11.0 -0.2 -2.0

Duties 13.2 16.9 -3.7 -21.9 15.0 -1.9 -12.5

Fees 29.6 13.5 16.1 119.3 17.3 12.3 70.9

Other revenues 26.6 37.0 -10.4 -28.1 29.7 -3.1 -10.6

Proceeds from loan repayments and funds carried forward from the previous year

7.9 5.1 2.8 54.9 8.5 -0.6 -6.9

Donations 6.6 6.6 0.0 0.0 5.6 1.0 18.8

ADDITIONAL FINANCING

Borrowings and loans from domestic sources 175,2 0,0 175,2 ... 244,9 -69,69 -28,5

Borrowings and loans from foreign sources 657,5 634,1 23,5 3,7 290,8 366,73 -91,9

Proceeds from sale of property 7,8 0,0 7,8 ... 6,7 1,15 17,2

Increase/decrease in deposits -7,6 0,0 -7,6 -0,2 -5,4 -2,28 42,6

Source: Ministry of Finance

9 Estimated GDP for 2015 amounted to 3.6 billion euros.

37

Macroeconom

ic Developm

ents in the Country

Budget expenditures of the budget amounted to 1.62 billion euros or 45% of the estimated GDP. The exenditures recorded an increase of 10.8% compared to 2014. If compared to the plan, expenditures increased by 3.4% (by 53 million euros) where the difference was mainly a result of growth recorded in the repayment of liabilities from the previous years, capital expenditures, expenditures for services, and transfers to institutions, individuals, non-governmental and public sectors.

Table 2.13

Budget expenditures in 2015 and comparison with 2014

Type of expendituresOutturn Plan

Difference relative to the

plan2014 Difference

relative to 2014

mil. € mil. € mil. € % mil. € mil. € %

BUDGET EXPENDITURES 1.618,0 1.565,0 53.0 3.4 1.460,8 157.2 10.8

CURRENT EXPENDITURES 1,390.0 1,280.3 109.7 8.6 1.393.1 -3.1 -0.2

Current budget expenditures 669.7 631.8 37.8 6.0 635.0 34.6 5.5

Gross salaries and contributions charged to the employer

382.2 379.4 2.8 0.7 387.3 -5.2 -1.3

Other personal earnings 14.7 11.6 3.1 26.9 12.0 2.8 23.3

Expenditures for material 25.6 29.4 -3.8 -13 28.6 -3.0 -10.4

Expenditures for services 58.5 41.5 16.9 40.8 54.1 4.4 8.1

Expenditures for current maintenance 20.1 20.8 -0.7 -3.3 21.3 -1.2 -5.4

Interests 81.8 75.8 6.0 8.0 75.5 6.3 8.3

Lease 7.9 8.3 -0.4 -4.9 8.0 -0.1 -1.4

Subsidies 19.6 21.3 -1.6 -7.7 18.4 1.2 6.5

Other expenditures 30.7 29.9 0.9 2.8 29.8 0.9 3.2

Capital expenditures in current budget 28.5 13.8 14.6 105.7 66.2 -37.8 -57.0

Transfers for social welfare 487.0 504.9 -17.8 -3.5 492.2 -5.1 -1.0

Social welfare related benefits 60.8 60.5 0.3 0.5 61.9 -1.0 -1.7

Funds for technological redundancies 16.7 19.4 -2.8 -14.3 22.6 -5.9 -26.3

Pension and disability insurance related benefits 387.0 402.5 -15.4 -3.8 384.4 2.7 0.7

Other healthcare related benefits 14.5 15.0 -0.6 -3.7 15.2 -0.8 -5.0

Other health insurance related benefits 8.1 7.4 0.6 8.6 8.1 0.0 -0.3

Transfer to institutions, individuals, non-governmental and public sector

136.2 128.3 7.9 6.2 99.0 37.2 37.5

Transfer to institutions, individuals, non-governmental and public sector

135.8 127.9 7.9 6.2 96.9 38.9 40.2

Other transfers 0.5 0.4 0.0 6.4 2.2 -1.7 -79.2

CAPITAL BUDGET 228.0 284.7 -56.7 -19.9 67.7 160.3 236.7

Borrowings and loans 3.0 2.3 0.7 32.3 2.5 0.5 19.8

Reserves 16.6 13.1 3.6 27.5 13.5 3.1 23.0

Repayment of guarantees 0.0 0.0 0.0 ... 15.3 -15.3 -100.0

Repayment of liabilities from the previous years 77.4 0.0 77.4 ... 65.2 12.2 18.7

Net increase in liabilities 0.0 0.0 0.0 ... 4.1 -4.1 -100.0

DEBT REPAYMENT 541.7 398.3 143.5 36.0 434.1 107.7 -67.0

Repayment of securities and loans to residents 221.7 46.7 175.0 374.7 239.0 -17.3 -26.8

Repayment of securities and loans to non-residents 320.0 317.8 2.3 0.7 195.1 125.0 -98.8

Repayment of liabilities from the previous years 0.0 33.8 0.0 ...

Source: Ministry of Finance

38


According to the Ministry of Finance estimates, the Budget of Montenegro generated deficit of 291.3 million euros or 8.1% of GDP in 2015, which is 184.1 million euros more than in 2014. This was the se-venth consecutive year of the budget deficit, which indicates still present pressure of this vulnerability on fiscal and overall financial stability of the system. Additionally, debt repayment amounted to 541.7 million euros (the amount that is not included in the deficit).

The implementation of the biggest infrastructure project in Montenegro - the construction of the part of the „Bar - Boljare“ highway, section „Smokovac - Mateševo“ started in 2015, which is funded from the capital budget and the funds were provided from the credit arrangement signed with the Exim Bank.

With regard to the public finances consolidation at the local level, the Government approved resche-duling of tax debt based on taxes and contributions for employees wages and salaries in the amount of 89.07 million euros.

According to the Budget Law of Montenegro for 2016, a deficit is planned in the amount of 273.9 milli-on euros (7.2% of GDP), while the planned primary fiscal deficit amounts to 197.4 million euros. The reason for the growth in fiscal deficit is repayment of the prior debt and the highway construction. However, it will be a challenge to keep the deficit within these limits.

Table 2.14

Plan for main Budget categories for 2016, in million euro

Source revenues 1,458.5

Taxes and contributions 1,331.4

Other revenues 127.1

Expenditures 1,732.4

Current budgetary spending 1,397.5

Capital budget of Montenegro 334.9

Deficit -273.9

Primary deficit -197.4

Debt repayment 393.2

Repayment of principal to residents 44.7

Repayment of principal to non- residents 309.2

Repayment of liabilities from the previous years 39.4

Shortfall -667.1

Financing 667.1

Borrowings and loans from domestic sources 10.0

Borrowings and loans from foreign sources 657.1

Source: Budget Law of Montenegro for 2016, (OGM 79/2015)

2.4. Public Debt

Data on the public debt as at 31.12.2015 were not available at the moment of compiling this report.

39

Macroeconom

ic Developm

ents in the Country

2.5. Balance of Payments

In 2015, the current account deficit recorded a decline. According to preliminary data, the cu-rrent account deficit amounted to 481.9 million euros, which is 8.3% less than in 2014. The decli-ne in the current account deficit resulted from the increase in the surplus at the services account and primary revenues.

A deficit in the goods account in 2015 amoun-ted to 1.5 billion euros, being 6.3% higher than one year ago. Total export of goods amounted to 325.2 million euros, showing a decrease of 9%. The decline in the export of meat and meat pro-ducts and electricity mostly affected the decli-ne in exports. Total import of goods amounted to 1.8 billion euros, and it was 3.1% higher than in 2014. The coverage of the foreign trade deficit with surpluses recorded in other current account sub-accounts amounted to 67%, recording a five percentage point y-o-y increase.

A surplus at the services account amounted to 789.2 million euros in 2015, which was the y-o-y increase of 14.3%. Total revenues from services amounted to 1.2 billion euros or 17.8% more y-o-y, while expenditure from services amounted to 424.8 million euros (growth of 24.8%). Increase in revenues from services resulted from positi-ve trends in the tourism and transport sectors. With regard to the observed period, a significant increase in foreign tourist overnights was recor-ded, 19.9%.

A surplus of 92.8 million euros was recorded at the primary income account, which was substan-tially higher than that recorded in 2014 (increase of 46.9 million euros). Revenues based on pri-mary income amounted to 247.7 million euros ,while expenditures were recorded in the amount of 154.9 million euros. Total expenditures declined by 14% in the observed period, due to smaller outflow based on interest repayment and paid dividends.

Surplus was recorded at the secondary income account in the amount of 98.8 million euros, which represented a y-o-y decrease of 13.7%. Total inflow of transfers to Montenegro declined by 6.6% com-pared to the previous year and they amounted to 171.9 million euros. The largest inflow was recorded

Balances of various balance of payments accounts, % of GDP, 2005-2015

Coverage of imports by exports, 2005-2015

Graph 2.4

Graph 2.5

Source: CBCG

Source: CBCG

40


based on personal transfers10 from abroad in the amount of 113.9 million euros. Transfer outflows to abroad amounted to 73.1 million euros over the same period, which is 4.9% more compared to 2014.

Preliminary data showed that net foreign direct investments amounted to 619.3 million euros in 2015, which is the y-o-y increase of 75%. The increase in net inflows resulted from the significant growth in investments in domestic companies and banks and a lower amount of withdrawal of foreign inves-tments compared to the previous year. Total FDIs amounted to 757.4 million euros or 52.1% more than in 2014. FDI inflow in the form of equity investments amounted to 490.3 million euros and it made up 64.7% of total inflows. Some 349.2 million euros referred to investments in companies and banks within equity investments, while the inflow arising from investments in real estates amounted to 141.1 million euros. Inflow arising from intercompany debt amounted to 255.2 million euros or 10.8% more than in 2014. Total FDIs outflow amounted to 138.2 million euros recording a 4.2% decrease in relation to the corresponding period of 2014.

With regard to the portfolio investments account, net inflow of 112.1 million euros was recorded in 2015, as a result of Government borrowings by issuing Eurobonds in the international capital market. The Other investments account11 showed a net outflow of 485.4 million euros and it was characterised by the decline in banks’ liabilities and other corporate sectors’ liabilities based on borrowings, while liabilities of the government increased.

A substantial FDI inflow in Montenegro in the previous period was recorded from the EU member states. Accordingly, negative trends in these countries could influence a further decline in capital in-flows. Taking into account a high correlation between capital inflow and economic growth, a decrease in capital inflows represents a threat to sustainability of Montenegro’s growth model, which is based on large spending and imports.

If observed isolated, the current account deficit is not necessarily negative in a situation in which it is connected with the balanced current (and/or future) economic growth. The structure of imports is important. The situation is worse if the import of investment goods (or consumer goods for investment purposes) is neglected in favour of consumer goods. The manner and sustainability of financing are also important: equity investments are, as a rule, more desirable than debt investments, particularly if indebtedness is already significant. In general, the balance of payment trends alone do not represent a threat to financial stability in the case of Montenegro, but they still point to the need for economic reforms and a change of the growth model of the economy.

2.6. Real Estate Market

In 2015, the real estate market continued to adjust the large supply to a limited demand, by reducing the prices of residential units. A declining trend of the real estate prices stopped in Q3 2015.

10 Based on the new methodology of the IMF (Balance of Payments and International Investment Position Manual, Sixth Edition, 2009, which has been applied by the CBCG since 2014, personal transfers are new category that represents wide concept of the recently used concept of workers' remittances. In addition to workers' remittances that cover only tran-sfers of migrants employed in foreign economies, personal transfers cover also other transfers between natural persons.

11 The included Government prepayment to the Chinese company CRBC for the highway construction was 170.5 million euros.

41

Macroeconom

ic Developm

ents in the Country

The results of the September survey showed that the average real estate price per square meter12 in Podgorica amounted to 939 euros, which is an increase of 1.97% if compared to March 2015. The chain index of the real estate prices trending shows that the decline of real estate prices (which started in June 2013 after a three-year stagnation) was stopped in September 2015. However, if the real estate pri-ces are compared in the period September 2014-2015, there was a decline in the real estate prices of 1%.

The latest survey of real estate agencies carried out by the CBCG also points to a drop in the real estate prices. To wit, 54% of the surveyed agencies believed that the real estate prices in Montenegro recorded an average decline of 10%-20% over the one-year period. In addition, 46% of the surveyed agencies re-corded a decline in turnover that averaged between 10% and 50%, while 29% of the surveyed agencies recorded an increase in turnover, between 10 and 30%, on average. Some 25% of the surveyed agencies had no changes in turnover.

Table 2.15

Summary statistics of average values of apartments per square meter in Podgorica

Period Price in euros Chain index Base index

September 2007 1.697,6 100,0 100,0

March 2008 1.738,3 102,4 102,4

September 2008 1.525,5 87,8 89,9

March 2009 1.402,1 91,9 82,6

September 2009 1.223,1 87,2 72,1

March 2010 1.128,3 92,2 66,5

June 2010 1.191,5 105,6 70,2

September 2010 1.177,1 98,8 69,3

December 2010 1.185,2 100,7 69,8

March 2011 1.171,2 98,8 69,0

June 2011 1.163,0 99,3 68,5

September 2011 1.174,0 100,9 69,2

December 2011 1.151,2 98,1 67,8

January 2012 1.168,3 101,5 69,0

June 2012 1.179,6 102,5 69,5

September 2012 1.172,3 99,4 69,1

December 2012 1.171,6 99,9 69,0

March 2013 1.169,4 99,9 68,88

June 2013 1.069,8 91,48 63,10

March 2014 971,4 90,80 57,22

September 2014 950 97,8 55,96

March 2015 920.8 96,9 54,24

September 2015 939 101,97 55,31

Source: CBCG

12 According to the Hedonic index obtained from the CBCG survey, where the prices do not reflect actual, realized prices, but essentially represent subjective prices of the real estate owners, i.e. prices below which they would not be willing to sell their property.

42


According to available data obtained from the September survey, the econometric model which asse-sses the effect of qualitative characteristics of an apartment to the price of the facility was prepared. Table 2.16 shows that, measured by the level of significance, the price of a residential unit is primarily influenced by the zone where the residential unit is located. To wit, residential units in the Zone 1 are more expensive in relation to the Zone 3, while the prices of residential units in the Zone 2 are cheaper than those in the Zone 3.13 If we consider the types of residential units, apartments are more expensive than houses. Moreover, the average and the control of other factors show that the price of a residential unit is more expensive if it is 10 years old than if it is older than that. The results suggest that apar-tments sized over 65m2 are cheaper than apartments under 65m2. Other qualitative features of the re-sidential unit such as whether a residential unit has a garage or not, type of heating, and the number of balconies have an impact on the price of residential units in Podgorica. Specifically, the results indicate that residential units with over two balconies are more expensive.

Table 2.16

Empirical results of the models for an average price of a dwelling, September 2015

lnprice Coefficient RobustStandard error t P>|t| [95% Conf. Interval]

lnm2 -.0583 .0514 -1.13 0.257 -.1594577 .0427756

pg_1 .155*** .0266 5.84 0.000 .103218 .2079299

pg_2 .0154 .0302 0.51 0.610 -.0439673 .0747738

apartment .1759*** .040 4.36 0.000 .09664 .2552453

over65 -.0583* .0303 -1.92 0.055 -.1179181 .0012609

t65 -.0336 .0502 -0.67 0.503 -.1323693 .0650966

upto5yrs .1961*** .0515 3.81 0.000 .094842 .297405

5_10yrs .093*** .0329 2.83 0.005 .0284915 .1578205

balcony2plus .1294** .0558 2.32 0.021 .0197166 .239241

balcony1 .00 .0483 0.05 0.960 -.0926723 .0975523

balcony2 .0289 .0529 0.55 0.585 -.0751216 .1329793

room2plus -.0218 .0447 -0.49 0.626 -.1097526 .0661012

room0 -.1826*** .0579 -3.15 0.002 -.2964484 -.0687567

room2 .0223 .0342 0.65 0.513 -.044862 .0896067

heat_wood -.0700** .0346 -2.02 0.044 -.1380885 -.002023

internet .006 .0299 0.20 0.840 -.0528641 .0649741

garage .1632*** .0390 4.18 0.000 .0864543 .2399749

_cons 6.88 .2162 31.83 0.000 6.456964 7.306817

Explanation: *** significance at 1%, ** significance at 5%, * significance at 10%Diagnostics: Number of observations : 463; R-squared = 0.4236; VIF= 2.62; F(3,441) = 1.66; Prob > F = 0.1742

The robustness tests showed that the model had been specified very well; there was no problem with its multicollinearity (extremely low values of the variance inflation factor - VIF) or the functional form (Ramsey Reset test).

13 Zone 3 was taken as the basis.

43

Macroeconom

ic Developm

ents in the Country

The average price of square meter of an apartment in newly constructed buildings was higher com-pared to the price represented by the Hedonic in-dex. Thus, in Q4 2915, the average price of a squ-are meter of an apartment in newly constructed building in Montenegro amounted to 1,114 euros which was the y-o-y increase of 7.4%. This incre-ase mostly resulted from an increase in the prices of apartments in newly constructed buildings in Bar (27%) and Podgorica (8%). In Q4, the highest average price of apartments in newly constructed buildings was contracted in Bar, amounting to 1,500 euros per square meter, followed by Budva with 1.194 euros, Podgorica with 1.119 euros and Nikšić with 579 euros per square meter. Accor-ding to the latest Monstat data, the sale of apar-tments in newly constructed buildings in Monte-negro in Q4 2015 recorded the quarter-on-quar-ter growth of 6.2%. However, it should be pointed out that it was a small volume of sale as only 239 apartments was sold in Q4 2015 in Montenegro.

The table below shows trends of the real estate prices in the selected countries according to the Global Property Guide. As it can be seen, divergent trends in real estate prices characterised 2015: the highest growth were recorded in Qatar (16.42%), and the biggest decline in the United Arab Emirates - Dubai (14.1%). It could be also noted that the European real estate market is recovering. As for the Balkan co-untries included in the Report, the annual price growth was recorded in Croatia (1.73%) and Romania (7.57%), while Macedonia and Greece saw a drop in prices.

Average prices of a square meter of apartments in newly constructed buildings in Montenegro,

in euros

Graph 2.6

Source: Monstat

44


Table 2.17

Real estate prices in selected countries (ranked according to the annual change in Q3 2015)

Country Annual change, Q3 2014, in % Trend assessment Annual growth rate

Q3 2015, in %Quarterly change,

Q3 2015, in %Qatar 37.20 ↓ 16.42 4.23

New Zealand 3.93 ↑ 14.86 7.10

Hong Kong 1.76 ↑ 12.64 1.12

Sweden 8.50 ↑ 11.26 3.83

Ireland 14.52 ↓ 9.24 4.93

Japan-Tokyo 0.39 ↑ 8.97 1.98

Romania -1.41 ↑ 7.57 3.76

Estonia-Tallin 15.39 ↓ 6.26 0.56

USA (FHFA) 2.95 ↑ 5.60 0.99

Mexico 0.01 ↑ 5.45 2.98

The Philippines 3.58 ↑ 5.41 1.27

Iceland 6.69 ↓ 5.27 1.12

China - Shanghai -0.45 ↑ 5.07 2.21

US (Case Shiller) 3.02 ↑ 4.96 1.34

Canada 3.31 ↑ 4.57 2.89

Puerto Rico -8.04 ↑ 4.51 1.88

Norway 1.32 ↑ 4.04 -0.65

UK 8.95 ↓ 3.64 0.71

Thailand 2.15 ↑ 3.40 3.15

The Netherlands 3.89 ↓ 2.75 2.23

South Korea 0.65 ↑ 2.62 0.72

Lithuania 4.62 ↓ 2.43 1.77

Israel 5.94 ↓ 2.33 -3.15

Latvia 4.71 ↓ 1.95 2.48

Croatia 0.00 ↑ 1.73 2.48

Slovakia -0.23 ↑ 1.43 0.93

Cyprus -5.52 ↑ 0.52 0.97

Spain -4.15 ↑ 0.49 1.37

Portugal 1.86 ↓ 0.03 1.16

Vietnam 1.45 ↓ -0.06 0.00

South African Republic 2.89 ↓ -0.19 0.69

Finland -1.80 ↑ -0.20 0.09

Indonesia 2.77 ↓ -1.49 -0.67

Taiwan 3.42 ↓ -2.95 -2.40

Singapore -4.55 → -3.62 -1.06

Macedonia 4.51 ↓ -4.02 -0.09

Greece -7.02 ↑ -4.35 -1.10

Ukraine-Kiev -36.12 ↑ -5.50 -0.61

Brazil – Sao Paulo 3.29 ↓ -5.54 -1.11

Egypt 19.08 ↓ -12.48 0.35

Russia -5.68 ↓ -13.38 -3.26

UAE –Dubai 23.73 ↓ -14.10 -3.79

↑ = increase in changes of prices of houses more than one percentage point → = increase in changes of prices of houses less than one percentage point← = decrease in changes of prices of houses less than one percentage point ↓ = decrease in changes of prices of houses more than one percentage point, y-o-y

Source: Global property guide, 2015.

45

Macroeconom

ic Developm

ents in the Country

Residential loans are significant determinant of demand in real estate market. Housing loans acco-unted for 8.6% of the estimated GDP at end-2015, having a downward trend if compared to 2014 and 2013. There is a considerable deleveraging and decline in lending activity, both in absolute and relative terms, which probably affected the restraint on the demand side.14

Table 2.18

Housing loans trend, 2005-2015

Year GDP in million €Housing loans,

End-year stock, in thousand €

Population14Housing loans, End-year stock

% of GDP Per capita (in €)

2005 1.815,0 11.259 623.277 0,6 18

2006 2.149,0 63.790 624.241 3,0 102

2007 2.680,5 222.592 615.875 8,3 361

2008 3.085,6 264.073 616.969 8,6 428

2009 2.981,0 349.042 618.294 11,7 565

2010 3.104,0 350.880 619.428 11,3 566

2011 3.234,0 325.793 620.029 10,1 525

2012 3.148,9 309.729 620.029 9,8 500

2013 3.327,1317.987

620.029 9,6 512

2014 3.457,9 315.089 620.029 9,3 508

2015 3.595,0 309.039 620.029 8,6 498

Source: CBCG, Ministry of Finance, Monstat

Long-term decline in real estate prices reflected on the growth in illiquidity of construction compa-nies which mirrored on the growth in borrowing of this sector to banking sector. During 2015, the exposure of the banking sector to the construction sector was the highest after the trade sector. The announced Government project „1000+ apartments“ will contribute to balancing demand and supply in apartments. The project is expected to generate positive economic effects as demand for housing construction will have positive effects on the construction sector as well.

Most of the surveyed real estate agencies (59%) expect that the prices will not change, 33% are of the opinion that prices will decline, while only 8% believe that prices will go up in 2016 compared to 2015. Nevertheless, 50% of agencies believe that the demand will remain the same, 29% of agencies expect an increase in demand for real estate, while 21% of agencies expect a decline in demand. As for the agencies’ expectation concerning the number of foreign buyers, majority of the surveyed agencies (42%) believe that the number will go down, while 37% of agencies is of the opinion that the number will remain the same in the next year, and 21% of agencies believe that the number will increase.

It is assumed that a slight revival of turnover in the real estate market will occur in the following period through the process of adjustment of the supply against demand, due to the expected growth in available income, „1000+ apartments“ programme and potential growth of FDIs in real estates.

14 The estimated population from 2007 until 2010 were revised based on the results of the 2011 Census (mid-year populati-on). Source: Monstat, Statistical Yearbook 2012

46


The course of realisation of important tourism and infrastructure projects in Montenegro in the following period will affect positively the revival of the construction sector. The growth in banks’ lending activity is expected in the following year as well as decline in lending interest rates, which could partially contribute to the revival of the real estate market. On the other hand, although a slight recovery of the real estate market is estimated in 2016, this segment of the economy still represents potential source of risks if the stagnation or further decline in the prices would occur as a result of extremely low enforcement of purchase agreement, stagnation in real wages and salaries, unexpected further unemployment growth or the Russian Ruble devaluation. Namely, citizens of the Russian Fe-deration who are owners of real estates in Montenegro could decide to cash out their immovable pro-perty by increasing an already high supply, which would result in a further decline of prices. However, it is estimated that this risk is not high at the moment.

47

Financial System

3. FINANCIAL SYSTEM

3.1. Banking System

Banking sector accounted for the main share in Montenegrin financial system, covering al-most 90% of the financial system assets.15 Total assets of the banking sector significantly incre-ased in 2015 (partly due to the entrance of two new banks in the Montenegrin market), and they amounted to 96.6% compared to to estimated GDP. Banks’ capital was primarily from foreign sources, which amounted to 80.4%16 of total capi-tal at end-2015, while stocks of domestic private and foreign capital amounted to 17.3% and 2.3%, respectively. The insurance sector reported a sta-ble growth for a longer period and, similar to the banking sector, the ownership structure of capi-tal is majority foreign owned. Assets and operati-ons of lease companies intensively decreased re-sulting in a decreased share of lease in financial system assets. 17

Microcredit financial institutions, as supplementary structure of the banking sector, intensified their operations in 2015 after several years of stagnation and decline, so their assets made up 1.4% of the banking sector. Total capitalisation at the Montenegro Stock Exchange was about 83% of the estima-ted GDP and it had trended down for longer period. Bearing in mind a low turnover, and almost a full absence of primary issues, it is clear that the stock exchange operations and, in general, the funding of companies through stock exchange, plays less prominent role in the financial and economic system.

15 Financial system assets accounted for 103.9% of GDP at end-2014 or 3.59 billion euros. Data for 2015 were not completed at the moment of drafting the report

16 The largest portion of foreign capital (77%) originated from Hungary, Austria, and Slovenia. 17 The remainder of the financial system at end-2014 consisted of: micro-financial institutions (1.1%), open-end invest-

ment funds (0.8%), closed-end investment funds (2.9%), investment fund management companies (0.5%), pension funds (0.03%), brokerage companies (0.1%), the Montenegro Stock Exchange (0.1%), and the CDA (0.03%).

Financial system structure,17 end-2014, %

Graph 3.1

Source: Relevant regulatory bodies

48


3.1.1. Capital

The solvency ratio was above the statutory minimum of 10% in all banks at end-2015, while the ag-gregate solvency ratio amounted to 15.49%. Moreover, banks were adequately capitalised at the end of every quarter in 2015. Tier 1 capital amounted to 14.24%.

Banks’ capital accounted for 13.3% of total assets and liabilities at end-2015, which was the y-o-y decli-ne of 0.8 percentage points, whereas total capital increased by 4.2%. Two new banks entered the mar-ket and their share capital amounted to 16.5 million euros. In 2015, three banks were recapitalised in the total amount of 11.9 million euros.18

Box 3.1 - Countercyclical capital buffers and credit-to-GDP gap

As the main response to the Global financial crisis and the Great recession that followed, a new version of Basel regulatory package, Basel III, was developed by the Committee on Banking Supervision of the Bank for International Settlements in Basel. The general position of regulators was that the previous versions of the Basel regulation were too much oriented towards microprudential supervision, i.e. they were focused on soundness of individual banks. In other words, they were not adequate in preventing the crisis of systemic proportions. In that sense, Basel III introduced a series of compulsory supervisory instruments of macroprudential nature. In the EU member states, Basel III was mainly implemented

18 Minimum, first quarter, system, third quarter and maximum, bottom up

Main capital ratios (left-hand scale), %, and total capital (right-hand scale), in million euros,

end-quarter, 2013-2015Solvency ratio dispersion in the system,18 %

Graph 3.2 Graph 3.3

Source: CBCG Source: CBC

49

Financial System

through CRD IV package, which covers the Directive 2013/36/EU and the Regulation 575/2013, which implementation started on 1 January 2014. Montenegro is currently transposing the provisions of these regulations in its regulatory framework, which will be finalised during 2017.

Countercyclical capital buffer is the most represented among the mentioned instruments. It is applied to every individual bank, but depending on the accumulation and development of systemic risks, pri-marily credit risk, at the level of entire system. If credit risk is too pronounced and above its long-term average, countercyclical capital buffer is activated in the form of the request to banks to allocate ad-ditional capital, which protects them for the accumulation of risk of strong credit growth and which curbs credit growth through price increase of sources of financing. Depending on the level of over-extensive credit growth, buffer would reach 2.5% of Common Equity Tier 1 (CET 1), a new definition of capital, becoming an upgrade of regulatory requirements for common equity tier 1 of 4.5%. If the issue of strong credit growth does not exist or if the growth is insufficient and below a long-term average, the countercyclical capital buffer is deactivated, i.e. it amounts to 0% which relieves banks’ funds for lending.

The credit-to-GDP gap or „credit gap“ is used as the key statistical indicator for the assessment of credit growth. This is defined as the differ-ence between the credit-to-GDP ratio and its long-term trend. Credit gap indicates the cur-rent situation with loans with regard to how „it should be“ in accordance with the trend which is an average, i.e. „a normal“ and gives informa-tion to macroprudential policy creators on the decision-making path. If the credit gap is posi-tive, i.e. the current credit-to-GDP gap ratio is above the long-term trend, the countercyclical capital buffer will be activated up to 2.5% of the common equity tier 1 depending on the size of the credit gap. However, if credit gap is negative, the countercyclical capital buffer will be deactivated, i.e. it is calibrated to 0% of com-mon equity tier 1.

There are many variations of the credit gap ratio, whereas the line of trend is determined using the Hodric-Prescott filter. The Central Bank of Montenegro developed for its analytical purposes base vari-ant of the credit gap ratio, while, as mentioned above, the regulation is in drafting procedure and once finalised it will enable the implementation of the instruments of countercyclical capital buffer. We note also certain technical restrictions of this indicator in the case of Montenegro, such as relatively insuf-ficient length of time series and certain „breaks“ in series of credits and GDP. Based on this indicator, credit gap of the banking sector in Montenegro was negative at end-2015, which would, if exists, coun-tercyclical capital buffer be deactivated, i.e. calibrated to 0% of common equity tier 1.

All EU member states are obliged to report to the European Systemic Risk Board on decisions related to the countercyclical capital buffer, as a macro-prudential authority at the EU level, which publishes national decisions on countercyclical capital buffer on its web site. As at 1 January 2016, all EU mem-ber states applied countercyclical capital buffer as an instrument whether calibrated to 0% or higher. Countercyclical capital buffer was calibrated in majority of the member states to 0% since majority of

Source: CBCG and Monstat; CBCG calculations

Graph 1Credit to GDP gap in Montenegro, end-2015

50


them had insufficient credit growth and therefore their credit gap was negative. However, Sweden and Norway (as non-EU member state) had countercyclical capital buffer of 1% of common equity tier 1 which was established in September and June 2015, respectively. Regulators in both countries also announced an increase in the buffer by end-June 2016, from 1% to 1.5%. With regard to the other EU member states, only the Czech Republic announced an increase in the countercyclical capital buffer above 0%, (to 0.5%) starting from 1 January 2017.

3.1.2. Banking Sector Profitability

The banking sector reported a negative financial result in 2015 in the amount of 3.4 million euros. Nine banks reported profit at the year-end, while five banks reported a negative result (one medium and four small banks). However, in addition to the aggregate loss, it should be pointed out that four out of five largest banks increased profit in the reporting year. The Law on the Conversion of Swiss Franc (CHF)-denominated loans into Euro (EUR)-denominated loans had a significant impact on the reported result of the banking system. Pursuant to the aggregate result, the return on average equity (ROAE) and the return on average assets (ROAA) amounted to -0.7% and -0.1% at end-2105, respec-tively. 19

19 Quarterly ROAE and ROAA were annualised multiplying ratio for Q, H1 and the first three quarters (by corresponding cumulative of net profit) by 4, 2, and 4/3, respectively.

ROAE and ROAA trend19, %, end-quarter, 2013-2015

Income and expenses by categories, 2013-2015, in thousand euros

Graph 3.4 Graph 3.5

Source: CBCG Source: CBCG

51

Financial System

Interest income and similar income recorded a decline as well as interest expenses, whereby a decline in expenses was more pronounced. Huge liquidity, which growth in the last three years was visible, is connected with a change in the structure of funding sources. On the other hand, weak lending activity and a certain decline in interest rates in the last period reduced banks’ earnings. In addition, competi-tion in the market increased with the entrance of new banks and the size of market and limits of Mon-tenegrin economy should also be born in mind. For that reason, it is likely that operating expenses will be more pronounced in the following period. The key difference in the 2015 financial result compared to last year were provision expenses20 and allowances for impairment.

Box 3.2 - Parent banks in financial markets in 2015

Fourteen banks operated in Montenegro in 2015, of which nine had majority share of non-residents in capital. Of that number, seven banks are fully (or almost fully) owned by non-residents - large banking groups from Austria (two banks), France, Hungary, Slovenia, Serbia and Turkey. Graphs 1 and 2 and Table 1 below display the prices of shares, CDS spreads, and bank ratings, as well as ratings of countries where the registered offices of those banks are located. Certain data were not available.

20 This was substantially due to the implementation of the Law on the Conversion of Swiss Franc (CHF)-denominated loans into Euro (EUR)-denominated loans.

Source: Bloomberg, CBCG calculations Source: Bloomberg

Graph 1Prices of shares of banks having their subsidiaries operating in Montenegro, 2014-2015, 01.01.2014=100

Graph 2CDS spreads of banks having their subsidiaries operating in Montenegro, 2014-2015, basis points

52


Table 1

S&P ratings (or equivalent) for banks having their subsidiaries operating in Montenegro (in alphabetic order) and their home countries, end-2015

Bank Rating Initial validity Country Rating

Erste Group Bank AG Vienna BBB+ 9 June 2015Austria AA+

Hypo Group Alpe Adria AG Klagenfurt no rating /

Komercijalna banka a.d. Beograd no rating / Serbia BB-

Nova Ljubljanska banka d.d. Ljubljana BB- 10 June 2014 Slovenia A-

OTP Bank Nyrt. Budapest BB27 November 2012

Hungary BB

Société Générale S.A. Paris A23 January 2012

France AA

T.C. Ziraat Bankası A.Ş. BBB- 20 May 2013 Turkey BB+

Source: Bloomberg

3.1.3. Total Assets and Liabilities Structure

Developments of main asset aggregates that were characteristic for 2014 continued also in 2015. Banks granted 20.1% more new loans than in 2014 (962.7 million euros), but total loans21 (outstanding debt, i.e. principal) recorded mo-dest growth. Same as in the previous year, banks’ assets growth was based on a significant growth in cash and deposits with central banks and also on a notable increase in investments in securities.

Borrowings, which reported decline for a num-ber of years, increased slightly in 2015, althou-gh it is far from the role they had in the funding structure until mid-2009. Banks continue to be funded largely through deposits which increa-sed by 13.7% during 2015. Non-resident deposits (Graph 3.9) became increasingly important, thus

21 Loans, if not stated otherwise, consist of loans granted to all sectors, deposits with banks and other depository instituti-ons and other receivables (factoring and forfaiting, receivables on acceptances, guarantees and bills of exchange outstan-ding). For instance, this is not applied to the statistics of new loans that cover only loans in narrow sense. Additionally, it is worth mentioning that the concept of value adjustments has been applied since 1 January 2013 according to the IAS 39, i.e. the concept of banks' own methodologies, while the calculation of regulatory provisions is used as the regulatory concept, and they are used further for the calculation of the solvency ratio. For more information see Financial System Stability Report for 2013, Box 3.1.

Assets structure, 2013-2015, end-month, in million euros

Graph 3.6

Source: CBCG

53

Financial System

being 21.5% higher and representing 19.8% of total deposits. Foreign assets and liabilities were relatively balanced. Liquid assets also continued to grow in this year, which indicated a certain deployment of funds, i.e. discretion in lending. Banks exposure to the government sector incre-ased.

Long lasting downtrend in the banking sector concentration continued also in 2015. Measured by the Herfindahl-Hirschman index, the situ-ation visually changed since initially extremely concentrated market and a dominant role of three largest banks, and the banking market is getting closer to becoming a really competitive market.

Total assets and liabilities increased 10.7% y-o-y at end-2015. In the assets structure, net loans stock declined by 5.5 percentage points to 64.4%, while cash and deposits with central banks increased by 2.5 percentage points to 18.4%. Se-curities were interesting for banks also in 2015, recording annual increase of 45.5%, and their share in assets increased by 2.4 percentage points to 10.2% of assets.

Lending to the private sector - households and the corporate sector increased annually by 3.1% and 2.0%, respectively. These were still insuffici-ent lending growth rates to instigate any stron-ger economic growth, but nevertheless they re-present a significant progress, i.e. a change from negative rates trend from the previous periods.

In the liabilities and capital structure, deposits increased by 2.0 percentage points to 75.6% of liabilities and capital at end-2015, since annual deposit growth amounted to 13.7%. Total depo-sits reached a historical peak in the middle of the reporting year. Household deposits have been beyond the 2008 level for a long period, and the data that corporate deposits reached their histo-rical peak this year is encouraging. Total deposits amounted to 2.62 billion euros at the year-end.

Liabilities and capital structure, 2013-2015, end-month, in million euros

Quarterly growth rate (q/q-4) of loans to private sector and GDP growth rate in nominal terms,

2011-2015, %

Graph 3.7

Graph 3.8

Source: CBCG

Source: CBCG, Monstat

54


With regard to maturity match of sources and placements, demand deposits increased from 42% to 50.7% of total deposits in the 2013-2015 period. Long-term deposits increased over the same period from 23.5% to 29.8% at the expen-se of short-term deposits which declined by 14.9 percentage points to 19.5%. 22

During 2015, foreign assets was approxima-tely the same in total assets and liabilities as in 2014, while the share of foreign liabilities was somewhat lower. Seasonal effect was noted in foreign assets due to the increase in cash in Q3, i.e. tourist season. Net foreign assets was positi-ve in the period August-October, and the net fo-reign assets-to-total assets ratio of 1.4% was the highest at end-September. Also, foreign liabilities

22 Deposits of private companies, deposits of state companies and deposits of entrepreneurs were taken for the corporate sector. The Government sector represents the General Government (central government, regulatory agencies, local self-government units, and state funds).

Deposits by sectors, 2006-2015, end-month, in million euros22

Total deposits by maturity, 2013-2015, % Household deposits by maturity, 2005-2015, end-month, in million euros

Graph 3.9


Source: CBCG

Source: CBCG Source: CBCG

55

Financial System

in the amount of 20.9% were at their lowest in October 2015 since 2007. The highest imbalance was recorded at end-April 2009, when foreign lia-bilities accounted for no less than 44.6% of total liabilities and capital, and net foreign assets were negative 35.5% relative to total assets and liabi-lities.

At the end of the year, the net foreign assets-to-total assets ratio was -4.4%, whereby foreign assets accounted for 17% and foreign liabilities accounted for 21.4% in total assets and liabilities.

Box 3.3 - Banks’ exposures to the Government

In the post-crisis period, the exposure of Montenegrin banks to the Government (central Government) has increased significantly both in absolute and relative terms. While the share of receivables to the Government in banks’ total assets was rather neglectable in the period 2007-2008, a gradual growth in this share started and reached 9.4% or 327.2 million euros at end-2015. In its structure, 40.2 million euros referred to loans (including also 3.6 million euros of loans granted to regulatory agencies), and 287 million euros referred to securities, whereas held to maturity securities accounted for 153.4 million euros and available for sale securities accounted for 133.6 million euros. However, the Government had claims on banks in the form of deposits and borrowings, which amounted to 170.6 million euros at end-2015. Therefore, net exposures of banks to the Government was 156.6 million euros or 4.5% relative to total assets.

Table 1

Banks’ exposures to Government, in thousand euros, end-period

2013 2014 2015

Loans 108.642 74.923 40.204

Securities 94.387 138.581 286.956

held to maturity 54.802 48.119 153.379

available for sale 39.585 90.462 133.577

TOTAL 203.029 213.504 327.160

of which: T-Bills for reserve requirement 46.981 44.318 53.426

Source: CBCG

Foreign assets, foreign liabilities and net foreign assets to total assets and liabilities,

2009-2015,end-month, %

Graph 3.12

Source: CBCG

56


Treasury bills are one of government securities banks have and which they partially (but not exclusively) hold to use the possibility of hold-ing their reserve requirement in T-bills issued by Montenegro. The Central Bank of Montenegro allowed banks over the years, with the excep-tion of 2008 and the first several months of 2009, since the beginning of the implementa-tion of reserve requirement instrument, to hold a portion of their reserve requirement in T-bills of Montenegro, and this portion amounted to 35% at end-2015. Banks were enabled to make higher yield and the Government met an im-portant portion of its liquidity needs through the issue of T-bills. However, due to the align-ment of the local regulations to EU legislation, this possibility will be gradually cancelled through the new central bank reserve require-ment decision which was adopted at end-2015. To wit, banks will be able to hold 25% of reserve requirement in the form of T-bills of Montene-gro until end-2016. After this period, banks may hold reserve requirement in the form of T-bills until the maturity of T-bills they will be holding as at 31.12.2016, but no longer than until end-June 2017. However, this does not mean that banks may not continue to hold Montenegrin T-bills after this period; it only means that they may not meet their reserve requirement using T-bills after this period.

Montenegro is not an exception when it comes to the growth in banks’ exposure to the Govern-ment in the post-crisis period compared to oth-er countries in the Balkans.23 With regard to the observed countries, banks in Albania and some in Greece recorded a decline in the exposure to government. Observed per the level of ex-posure at end-2015, Montenegrin banks would be in the middle, in general close to the level of banks of Bulgaria where the exposure to gross assets amounted to 9.7%. Croatian and Serbian banks’ exposures to government compared to gross assets was 21.6% and 15.7%, respectively, while this ratio for banks in Bosnia and Herzegovina, Kosovo, and Macedonia was 6%, 6.7%, and 7.2%, respectively.

23 Overview is given using data from the IMF base International Financial Statistics. There were no data on (net) assets, only on gross assets, which was used as denominator for the calculation of ratio, which should not have important impact on the illustration of banks' exposures to the Government. This data base did not include data for Montenegro and Slovenia.

Source: CBCG

Source: IMF (International Financial Statistics); CBCG calculations

Graph 1Banks’ exposures to Government, % of banks total assets, end-period

Graph 2Banks’ exposures to Government, % of banks total assets, end-period

57

Financial System

3.1.4. Credit Risk

Credit risk is the largest risk in the banking sec-tor. Besides significant decline in non-perfor-ming loans during 2015, the balance and share of these loans was still high. Since banks’ lending policies are more prudent, negative impact of cre-dit risk on capital should be lower. On the other hand, the largest income of banks was from in-terest income and it is likely that the banks will additionally diversify their investment policies in the future.

Banks ended 2015 with the share of non-perfor-ming loans in total loans of 12.6%24 (with the amount of 300 million euros), i.e. this share decli-ned by 3.3 percentage points y-o-y. Past due loans over 30 days also declined from 18.8% to 14.8% (352 million euros). In 2015, banks maintained a substantial level of portfolio of restructured lo-ans although these loans declined by 16.8% to 315.1 million euros, while their share in total lo-ans fell by 3.6 percentage points to 15.8%.

Non-performing loans coverage ratio25 was the same compared to the previous year-end (39.5%), which was relatively low coverage. The net non-performing loans-to-capital ratio was more fa-vourable at end-2015 as it fell from 54.8% at end-2014 to 42.5%, as a result of a decline in non-per-forming loans and an increase in capital. 26

NPL trends will largely depend on the liquidity of local economy which is one of the key sour-ces of risks in the country. The progress would be basically achieved through an increase in econo-mic activity on a sustainable basis - through new investments that would create new job opportu-nities for the population, direct capital flows to Montenegro, and a decrease in the current acco-unt deficit. The realisation of planned and initia-

24 Loans subject to comments in this report refer to gross amounts (with value adjustments), while the corresponding inte-rest receivables and prepayments and accruals for fees (interests) are not included, unless otherwise stated.

25 Value adjustments for losses on non-performing loans to non-performing loans ratio26 Ratios illustrated on this Graph and the related paragraph refer to loans with corresponding interest receivables and

prepayments and accruals for fees (interests).

Total non-performing loans (right-hand scale) in million euros, and the shares of selected

categories of NPLs (left-hand scale) in %, end-month, 2013-2015

Ratios of loan quality, 2013-2015, %, end-month26

Graph 3.13

Graph 3.14

Source: CBCG

Source: CBCG

58


ted projects - highway constructions, energy projects and large tourism projects would act as a catalyst of economic activity in short- and medium-term. It is also important to resolve many structural pro-blems in the medium-term.

It can be concluded that the economy poses the largest source of credit risks looking at the sha-re of past due loans over 30 days in the corporate sector27 and households - 24.4% and 11%, respec-tively. However, a huge decline in the share of the-se loans with both sectors is worth mentioning. A higher level of past due loans with the corporate sector compared to households is not an unusu-al situation since the household sector, due to a different type of loan impairment and non-availa-bility of limited liability, is forced to be more dis-ciplined. Besides, causes of the problem in Mon-tenegro should be searched in the structure of the economy (import-oriented economy and the mar-ket itself), i.e. in the problems in certain sectors of the economy, the functioning of which substanti-ally is based on the inflows from financial account of balance of payments bearing in mind that the-se inflows have been declining for the last several years. On the other hand, a significant portion of employees (households) works in the government sector, which position was not that unsteady over the same period, mostly owing to the possibility of foreign borrowing by this sector.

Sensitivity analysis results confirmed that credit risk is the most prominent risk in the Montenegrin banking system, whereby four shocks were realised: (1) reclassification of loans and receivables and implementation of value adjustments prescribed in accordance with the methodologies of individual banks (A, B, D, and E) and the average value adjustments (C); (2) an increase in non-performing loans (C, D and E) and required amount of values adjustments; (3) default or bankruptcy of one debtor – borrower whose exposure is calculated in accordance with the mean value of 20 largest borrowers of a bank, decreased by the amount of average value adjustments on this basis; (4) default by the largest, top 1 borrower of a bank, decreased by the amount of value adjustments on this basis.

Due to assumptions for shock 1, the solvency ratio decreased with 13 banks. The solvency ratio incre-ased only with the new bank, since it does not have non-performing loans. The solvency ratio at the aggregate level decreased from 15.49% to 10.56%. Six banks in the system recorded the solvency ratio below the statutory minimum of 10%. A decrease in the solvency ratio with thirteen banks ranged from 0.74 to 17.15 percentage points. The banks should provide capital of 42.7 million euros to reach the prescribed level of the solvency ratio of 10%.

27 Legal persons cover also government sector in this case; otherwise the ratio that would refer strictly to the corporate sector would be even higher.

Past due loans over 30 days, 2013-2015, %, end-month

Graph 3.15

Source: CBCG

59

Financial System

The aggregate solvency ratio in shock 2 decreased from 15.49% to 14.63%. A decrease in the solvency ratio with thirteen banks would range from 0.13 to 1.91 percentage points. After this shock, none of the banks in the system would show the solvency ratio below the statutory minimum of 10%.

Shock 3 was applied to the initial balance of in-dividual banks and the system as a whole as at 31 December 2015, and it resulted in the solvency ratio decrease from 15.49% to 14.35% at the ag-gregate level. A decrease in the solvency ratio with thirteen banks would range from 0.13 to 1.59 percentage points. After this shock, none of the banks in the system would show the solvency ratio below the legally prescribed minimum of 10%.

Shock 4 was also applied to the initial balance of individual banks and the system as a whole as of 31 December 2015, and it resulted in the solvency ratio decrease from 15.49% to 5.99% at the aggre-gate level. Thirteen banks would report a decline in the solvency ratio. Eight banks would report the solvency ratio below the prescribed mini-mum of 10%, which would require additional ca-pital in the amount or 117.4 million euros.

Box 3.4 - Key indicators of financial stability in the Balkan countries

As a part of the monitoring of economic and financial situation by countries, the International Mon-etary Fund also collects data on financial stability indicators. The IMF developed the Financial Sound-ness Indicators Compilation Guide/Handbook, which gives a uniform methodological basis for the production of internationally comparable data. Almost half of the IMF member countries report to the IMF on financial soundness indicators in a structural manner and using the methodology from the handbook. However, there is a number of countries that report to the IMF using different bases and not necessarily the handbook methodology. In this second group of countries, which also includes developed economies, is Montenegro, Albania, and Serbia as the regional countries.

The latest available data are from the IMF Global Financial Stability Report from October 2014, where data in certain cases refer to different months of 2015, which does not have the major impact on com-parability.28 According to these data, if developed economies are compared with the emerging/devel-oping economies of Central and East Europe, certain expected differences are noticeable. The banking sectors of the economies of Central and Eastern Europe face more problems with bad loans in general, while capitalisation is better compared to developed economies. In addition, the banking sectors of

28 The CBCG has data for Montenegro for end-2015, i.e. entire 2015, but the IMF data have been kept on purpose in this overview due to the consistency of sources for all countries.

Credit risk sensitivity analysis – aggregate solvency ratio, 30 December 2015

Graph 3.16

Source: CBCG

60


developed economies have somewhat better profitability compared to the banks in Central and East Europe, which profitability was affected by large problems with NPLs loans.

As for the Balkan countries, banks from Croatia and Serbia are best capitalised with the solvency ratios of 22.3% and 21.4%, respectively, while the worst capitalised banks are from Greece with 12.7%. Mon-tenegrin banks’ solvency ratio is below the average although it is high above the Basel and statutory criteria. Also as expected, the worst banks with regard to bad loans are those from Greece with even 34.4%. They are followed by banks from Serbia and Croatia, where the share of NPLs in total loans was 22.8% and 17.1%, respectively. The best banking sector on this basis is the one from Kosovo where NPLs accounted for 7.1% in total loans. With regard to profitability, the banking sector of Kosovo was the best, where between banks ROA was at the level of 1.8% and ROE was high at 16.2%, likely due to a relatively poor competition.

Table 1

Key indicators of financial stability in the Balkan countries, % (the latest available data from 2015)

Country Solvency ratio Capital Assets NPLs, stock Provisions

NPLsProfitAssets

Profit Capital

Albania 16,0 9,7 20,9 68,7 1,3 14,2

Bosnia and Herzegovina 16,3 15,0 14,1 70,1 0,7 5,7

Bulgaria ... ... ... ... ... ...

Montenegro 15,9 14,2 16,7 45,5 0,8 2,8

Greece 12,7 7,7 34,4 55,4 -0,5 -5,4

Croatia 22,3 13,8 17,1 57,9 0,8 6,0

Kosovo 19,2 11,8 7,1 86,0 1,8 16,2

Macedonia 16,2 11,0 11,0 106,0 1,0 9,4

Romania 18,6 8,3 13,9 70,2 0,9 8,9

Slovenia 18,0 ... 11,5 64,0 0,4 3,2

Serbia 21,4 21,2 22,8 113,2 1,1 5,4

Source: IMF (GFSR FSI Tables, October 2015)

3.1.5. Liquidity Risk

Banks were not significantly exposed to liquidity risk bearing in mind that the assets growth was guided by liquidity growth and that a large portion of these funds exists in the form of foreign place-ments at sight.

Liquid assets29 accounted for 24.7% of total assets at end-2015 and it made up 860.2 million euros, which was the y-o-y growth of 23.4%. The coverage of short-term liabilities with liquid assets recorded a similar trend and it amounted to 40.2% at end-2015. The loans-to-deposits ratio had been constantly declining and it fell below 100% in 2015. Cash recorded a high annual growth of 28.4%.

29 Accounts nos.:1001-4, 1007-10, 1012, 1122, 1126-27, 1130, 1134 and 1138 (see annex to the Decision on the Chart of Acco-unts for Banks), plus 50% of allocated reserve requirement.

61

Financial System

Ten-day liquidity indicator was significantly abo-ve the statutory minimum during 2015 and it had a similar trend as liquid assets.30

When testing banks’ sensitivity to liquidity risk, the following shocks were run and results were as follows:31

a) Shock 1: Withdrawal of 30% of the total amo-unt of deposits

Loss of depositors’ confidence in the banking system was simulated and it resulted in the withdrawal of 30% of total deposits with all banks. In these conditions, thirteen banks in the system would show a lack of liquid assets of 402.8 million euros and the banking system would be illiquid. If the reserve requirement of 50% were to be used, twelve banks would still be illiquid, as well as the whole system.

30 This indicator was the liquid assets-to-matured liabilities ratio, and minimum allowed level in a ten-day period is 1 based on the Decision on Minimum Standards for Liquidity Risk Management in Banks (OGM 60/2008). The same De-cision contains the definition of liquid assets and matured liabilities. We note that liquid assets are different category as compared to to immediately available liquid assets and available liquid assets (see below).

31 Banks’ ability to cover the loss was tested through the following: 1) immediately available liquid assets (the difference between cash and deposits with central banks and allocated amount of reserve requirement), and 2) available liquid assets (immediately available liquid assets increased by 50% of the reserve requirement amount).

Liquid assets ratio (left-hand scale) and loans-to-deposits ratio (right-hand scale), %,

end-month, 2010-2015

Ten-day liquidity indicator, 2012-2015Selected liquidity indicators (left-hand scale)

and WADEIR (right-hand scale), %, end-month, 2010-2015

Graph 3.17

Graph 3.19Graph 3.18

Source: CBCG

Source: CBCGSource: CBCG

62


b) Shock 2: Withdrawal of 30% of demand deposits

Demand deposits’ share in total deposits was 50.08%. If 30% of these deposits were to be withdrawn, the banking system would still be illiquid, and seven banks would show a lack liquid assets. The system as a whole would be illiquid in the amount of 6 million euros. After using reserve require-ment funds, five banks would still be illiquid but not the system as a whole.

c) Shock 3: Withdrawal of 20% of household demand deposits and 30% of corporate demand deposits

The simulation of withdrawal of 20% of households’ demand deposits and 30% of corporate de-mand deposits would result in a lack of liquid assets with six banks, but not the system as a whole. After using reserve requirement, four banks would still be illiquid but not the system as a whole.

d) Shock 4: Withdrawal of 30% of household time deposits and 30% of corporate time deposits

The simulation of withdrawal of 30% of household time deposits and 30% of corporate time depo-sits would result in alack of liquid assets with seven banks, but not the entire banking system. If the reserve requirement were to be used in the amount of 50%, five banks would still be illiquid, but not the entire banking system.

e) Shock 5: Withdrawal of deposits by the largest depositor

The concentration of deposits by one depositor (top 1) in seven banks was lower than 10%. If the withdrawal of these deposits had occurred, sensitivity analysis results showed that four banks wo-uld have liquidity problems and the entire system would be liquid. With the use of reserve require-ment, three banks would still be illiquid in the amount of 15.7 million euros.

f) Shock 6: Withdrawal of 50% of deposits of the ten largest depositors

The concentration of deposits of ten largest depositors was evident with all banks ranging from 11.26% to 89.87%. If these deposits were withdrawn in the amount of 50%, six banks would be illiquid. After using reserve requirement funds, five banks would still be illiquid but not the system as a whole.

g) Shock 7: Withdrawal of 100% of state deposits

The concentration of state deposits to total deposit ratio would amount up to 21.88%. High concen-tration of the government deposits in relation to total deposits (over 10%) would be evident with six banks. Sensitivity analysis of banks’ liquidity was performed assuming that the government depo-sits would be withdrawn in the amount of 100%. In this situation, four banks would still be illiquid but not the system as a whole. Three banks would still be illiquid in the amount of 49.3 million euros despite the use of the reserve requirement, while the system as a whole would be liquid.

3.1.6. Market risks32

Interest rate risk, with regard to trading activities, almost does not exist in the banking sector of Montenegro since trading positions that would be affected by the interest rate change are neglectable.

32 This section refers to two forms of market risk: interest rate risk and FX risk.

63

Financial System

Interest rate risk in non-trading activities exists but banks usually transfer it to their customers.

Interest rate spread33 at the banking system level slightly declined in 2015 since a decline in inte-rest income was higher than a decline in inte-rest expenses in 2015. At end-2015, spread at the system level amounted to 4.62 percentage points (compared to 4.94 percentage points at end-2014), while it differed by banks significantly ranging from 1.46 to 6.46 percentage points. This was a significant decline compared to the last year and the spread could be even lower in the following period.

Euroised economy and good management of FX risk influenced the low level of this risk. Aggrega-te net open foreign currency position of the ban-king sector amounted to seven million euros or 2.3% of core capital at end-2015.35 The U.S. dollar was the most presented foreign currency (both sides of the balance sheet) while the highest net open position at the system level was the position in U.S. dollars.

The majority of loans was denominated in euros. Only two banks, of which one is new and one is a small bank have a significant share of loans in their loan portfolios in foreign currencies (10.6% and 72.7%, respectively), while at the system level their share was only 1.55%.36

The sensitivity of assets and liabilities’ positions to interest rate risk was tested applying the incre-ased level of interest rate of 2 percentage points to a cumulative difference (gap) between assets and liabilities positions sensitive to the change of interest rate at the level of individual bank and the system as a whole. The sensitivity analysis re-sults of direct influence of the interest rate sensi-

33 Interest rate spread was calculated as the difference between the interest income to average earning assets ratio and in-terest expenses to average interest-bearing liabilities ratio.

34 Quarterly ratios were annualised multiplying ratio for Q1, H1 and the first three quarters (by corresponding cumulative of net interest income/expenses) by 4, 2, and 4/3, respectively.

35 Decision on Capital Adequacy of Banks (OGM 38/2011, 55/2012) provides more information on the core capital scope. 36 This refers only to loans in narrow context.

Interest rate spread, 2013-2015, %34

Aggregate net positions by currencies in 2015, in thousand euros, end-month

Graph 3.20

Graph 3.21

Source: CBCG

Source: CBCG

64


tive assets and liabilities indicated a decrease in the solvency ratio at the system level. To wit, the aggregate solvency ratio decreased from 15.49% to 15.34%, while a decrease in nine banks at the system level ranged between 0.10 to 0.73 percen-tage points.

Sensitivity analysis of direct FX risk was based on the net open FX position (so-called spot positi-on), i.e. on the assumption that own funds would be adjusted by 40% of the value of the net open position both at the individual bank level and the system level. The aggregate solvency ratio after the stress tests would decrease from 15.49% to 15.35%, while it would decrease in eleven banks from 0.01 to 1.25 percentage points.

Box 3.5 - Securities and other foreign currencies

One of the important characteristics of the banks’ asset reclassification in the post-crisis period was an increase in the placement of securities. While these placements amounted to 26.3 million euros (or below 2% of banks’ total assets) at end-2006, they were 62.7 million euros at end-2010, and reached even 353.1 million euros or around 10% of banks total assets at end- 2015. On the other hand, the share of cash and deposits of banks with the CBCG declined in the pre-crisis period and recovered after the crisis, while the share of loans grew in the eve of the crisis and then it declined. For example, cash and deposits of banks with the CBCG amounted to 19.5%, 9.4%, and 18.4%, and the share of net loans amounted to 74.1%, 86%, and 64.4% of banks total assets at end-2006, 2008, and 2015, respectively.

With regard to the type of classification, held to maturity (43,6%) and available for sale securities (56.1%) accounted for the main share at end-2015. In other words, trading securities had a small share (0.8%), i.e. there was a small number of banks oriented towards short-term return, which is usually implied by the speculative profile of these securities. In addition, relative safety was evident due to the fact that 81.3% of this portfolio referred to securities issued by the Central Government. A smaller por-tion referred to debt securities issued by non-residents (13%) and shares of Montenegrin companies (4.6%), while the remainder referred to all other types of securities and issuers.

Market risk sensitivity analysis – Solvency ratio, 30 December 2015

Graph 3.22

Source: CBCG

65

Financial System

Table 1

Securities, in thousand euros, end-period37

2013 2014 2015 2015, %

held to maturity 54.802 48.119 153.979 43,6

Government of Montenegro 54.802 48.119 153.379 43,4

Other residents 0 0 600 0,2

non-residents 0 0 0 0,0

available for sale 103.176 189.262 198.014 56,1

Government of Montenegro - debt 39.585 90.462 133.577 37,8

Government of Montenegro - equity 0 0 0 0,0

Other residents - debt 8 9 4 0,0

Other residents - equity 5.211 8.783 16.091 4,6

non-residents - debt 56.984 88.424 45.870 13,0

non-residents - equity 1.388 1.584 2.472 0,7

trading securities 2.781 3.207 2.820 0,8

Government of Montenegro - debt 0 0 0 0,0

Government of Montenegro - equity 0 0 0 0,0

Other residents - debt 0 0 21 0,0

Other residents - equity 1.412 1.381 394 0,1

non-residents - debt 0 0 0 0,0

non-residents - equity 1.369 1.826 2.405 0,7

Non-amortised discount/premium 743 2.129 -1.759 -0,5

TOTAL 161.502 242.717 353.054 100,0

Source: CBCG

At 2015 year-end, the largest level of investments in instruments denominated in currencies other than euro was recorded in the amount of 213.3 million euros or somewhat above 6% of banks total assets. Assets in other foreign currencies grew from end-2006 to end-2010 from 41.2 million euros to 182.7 million euros, followed by a decline, and then in the period 2011-2014 it was stagnant within the range of 110-130 million euros, significantly increasing y-o-y in 2015. Observed by currencies, the Swiss Franc accounted for the main share immediately before and during the crisis, when its share started declin-ing and the share of the U.S. dollar started increasing. At end-2015, 74.8% of the foreign currency port-folio referred to the U.S. dollar, 12.6% referred to the Swiss Franc, 10.9% to the British Pound, while the remainder referred to other foreign currencies. Observed by instruments, at end-2015, 73.7% of assets in other foreign currency referred to deposits (placed with banks abroad), 14.5% were loans (placed mostly to local corporate and household sectors), 9.7% were cash in vaults of banks or certain cash equivalents, and only 2.1% were foreign securities.

37 Securities are given in gross amounts (with prepayments and accruals) and without fees and prepayments and accruals on fees. Moreover, the inclusion of cumulative non-amortised discount/premium (second to last row of the Table) limits the most precise division of securities by the type and issuer, but due to the size of the position, this effect is small.

66


Table 2

Assets in other foreign currencies, in thousand euros, end-period

USD CHF GBP RSD Other TOTAL

2006 37.008 2.675 833 12 710 41.238

2007 41.945 80.942 1.398 28 1.076 125.389

2008 29.693 119.104 984 35 1.162 150.978

2009 62.371 110.527 643 17 931 174.489

2010 54.282 125.510 1.513 32 1.399 182.736

2011 54.141 66.879 2.284 38 2.238 125.580

2012 69.986 44.653 1.957 46 2.084 118.726

2013 69.999 36.815 3.011 23 1.957 111.806

2014 89.484 34.354 2.525 49 2.607 129.019

2015 159.610 26.918 23.335 20 3.420 213.304

2015, % 74,8 12,6 10,9 0,0 1,6 100,0

Source: CBCG

Such trend in assets was very much connected with the trend in liabilities in other foreign currencies, since the banks constantly adjust the positions in assets and liabilities by individual other foreign cur-rency to protect from FX risk, i.e. undesirable changes in exchange rate of other foreign currencies in relation to euro. At end-2015, 152.8 million euros of liabilities in other foreign currencies referred to U.S. dollar, 28.2 million euros was in Swiss Franc, 23.3 million euros referred to the British Pound and 2 million euros referred to all other foreign currencies. Observed by instruments, the largest portion of liabilities in foreign currency referred to deposits, 181.7 million euros (where demand deposits of 145 million euros accounted for the main share), followed by borrowings from parent banks of 22.6 million euros. With regard to the currency and instrument combination, it implied mostly demand deposits in the U.S. dollars, with depositors being resident or non-resident legal persons or households. These U.S. dollar funds were mostly placed as demand deposits with banks abroad. Liabilities in British Pounds were in the form of demand deposits and mostly concentrated with one bank. Those deposits were placed by non-resident legal persons and further invested as demand deposits with banks abroad. As for liabilities in the Swiss Francs, they were mostly concentrated with one bank as borrowings from parent bank. They were mostly disbursed to resident natural persons, and since no new lending has occurred in Swiss Francs for years, the balance of these loans have been continuously decreasing.

3.1.7. Interest rates

Multi-year trend in lending and deposit interest rates decline continued in 2015 as well. Thus, the weighted average lending effective interest rate (WALEIR) on total loans was 8.53% at end-2015 and it fell y-o-y by 0.69 percentage points. The weighted average deposit effective interest rate (WADEIR) dropped from 1.86% to 1.23% over the same period.38

38 Data on lending interest rates whether for new loans or total loans (outstanding debt, i.e. principal) referred only to loans in a narrow sense. Simultaneously, it should be mentioned that the statistics of deposit interest rates referred to total deposits (debt/banks' liabilities on deposits), while the statistics on interest rates on new deposits does not exist.

67

Financial System

Large liquidity growth that characterized the Montenegrin banking sector since H2 2012 also influ-enced the WADEIR which dropped by 2.04 percentage points by end-2015 (Graph 3.18). The WALEIR dropped by 1.0 percentage points over the same period. On the other hand, the WALEIR on new loans that ranged above the equivalent rate on total loans (outstanding debt, i.e. principal) during 2015 re-corded a higher decline. However, data that this rate was below the rate on total loans is encouraging.

The WALEIR on new loans39 was 8.12% in December 2015, which was 0.9 percentage points less com-pared to 9.02% from December 2014. Both sectors, corporate and household, recorded decline.

Box 3.6 - Interest rates in euro area countries, with an overview of Montenegro

In order to destimulate savings and stimulate investments and spending and thereby influence the economic activity growth, i.e. target medium-term inflation to a desirable below but close to 2%, the European Central Bank continued with the policy of record low interest rates in 2015. The interest rate on main refinancing operations rate during 2015 was 0.05%, while the interest rate on overnight on de-posits of banks held with the Eurosystem, as a more relevant rate for market interest rates, was reduced from -0.2% to -0.3% in December 2015. Consequently, this reflected on interbank market interest rates (EONIA and EURIBOR), as well as interest rates under which banks grant loans to the private sector or rates under which the private sector deposited funds with banks.

39 The amounts of new loans (which ultimately do not have the role of weight for determining aggregate interest rates) re-present contracted but not actually paid amounts. In addition, the fact that a certain number of new loans is approved for refinancing, i.e. repayment of old loans with other or the same bank calls for caution in the interpretation of data on interest rates on new loans and data on the amounts of new loans.

Weighted average lending effective interest rate on new loans (during month) and total

loans (end-month), %, 2012-2015

Weighted average lending/deposit effective interest rates end-month, %, September

2008-2015

Graph 3.24Graph 3.23

Source: CBCGSource: CBCG

68


With regard to nominal interest rates on new loans in the euro area, interest rates on housing loans granted to households were 2.2% which was 2.5% less compared to December 2014. To that end, inter-est rates varied by countries, whereas the cheapest housing loans were for citizens of Finland, Luxem-bourg, Lithuania, Germany and Austria who borrowed loans at interest rates of 1.3%, 1.8%, 1.9%, 2% and 2%, respectively. The most expensive housing loans were for the citizens of Ireland, Cyprus and Latvia, which borrowed loans at interest rate of 3.4%, 3.3% and 3%, respectively. Simultaneously, ef-fective interest rates on housing loans in the euro area was 2.6% and on consumer loans was 6.3%. On the other hand, at the euro area level, interest rate on loans to corporate sector (all purposes of loans) was 2.1%, which was lower than 2.4% from December 2014. The rates were also different by countries: the cheapest was for corporate sector of Luxembourg, the Netherlands, and France, at 1.2%, 1.6%, and 1.7%, respectively, while the most expensive were those to the corporate sector of Greece and Cyprus at 5.3% and 4.6%, respectively. Interest rates on all loans and deposits were higher than those on new loans, as expected, due to the inclusion in the alculation previously granted loans and deposits from period when interest rates were higher.

Table 1

Nominal interest rates in euro area, new loans, %

Country

Loans Deposits

Households Corporate sector Households Corporate sector

Consumer HousingComposite expense, housing

up to million euros

over million euros

Composite expense, all

purposesdemand

time up to one

yeardemand

time up to one

year

Austria 4,2 1,9 2,0 2,0 1,7 1,9 0,2 0,5 0,1 0,1

Belgium 3,5 2,5 2,4 1,8 1,6 1,9 0,1 0,2 0,1 0,1

Estonia 9,1 2,1 2,2 3,3 2,1 2,4 0,0 0,2 0,0 0,0

Finland --- 1,3 1,3 2,8 1,5 1,8 0,2 --- 0,0 ---

France 4,7 2,1 2,3 2,0 1,4 1,7 0,1 1,3 0,2 1,5

Greece 7,9 2,7 2,7 5,3 5,2 5,3 0,2 0,4 0,2 0,3

The Netherlands

6,2 2,4 2,8 3,0 1,1 1,6 0,3 0,4 0,1 0,4

Ireland 7,4 3,3 3,4 4,5 2,5 3,0 --- 1,0 0,2 1,1

Italy 5,0 2,0 2,3 2,7 1,2 2,2 0,1 1,5 0,2 0,1

Cyprus 4,6 3,3 3,3 4,8 4,1 4,6 0,2 0,4 0,2 0,1

Latvia 20,1 2,8 3,0 4,4 3,4 3,5 0,1 0,1 0,1 -0,1

Lithuania 6,9 1,8 1,9 2,9 2,2 2,2 0,0 0,5 0,0 0,8

Luxembourg 5,0 1,8 1,8 1,8 1,0 1,2 0,2 0,9 0,1 0,0

Malta 4,8 3,1 2,9 1,7 3,6 3,6 0,1 1,7 0,1 0,3

Germany 5,7 2,2 2,0 2,6 1,4 2,0 0,1 0,3 0,0 0,1

Portugal 7,1 2,1 2,2 3,6 2,6 3,3 0,0 0,3 0,0 0,2

Slovakia --- 3,0 2,6 3,0 2,5 2,5 0,2 0,8 0,0 ---

Slovenia 4,2 2,2 2,4 2,9 2,2 2,4 0,0 1,5 0,0 0,4

Spain 4,4 1,8 2,0 3,0 2,0 2,4 0,1 1,4 0,2 0,2

euro area 4,8 2,0 2,2 2,7 1,5 2,1 0,1 0,7 0,1 0,2

In addition to data on composite expenses, data on loans referred to loans with variable interest rate for the entire repayment period and to those with fixed interest rate in the first year of repayment.

Source: ECB

69

Financial System

In addition to a declining trend, lending interest rates in Montenegro were generally 4 percentage points higher than those in the euro area. In Montenegro, the weighted average nominal lending in-terest rate for the household sector amounted to 8.4%, in December 2015 and to corporate sector was 6.4% compared to 2.2% (only for housing loans) i.e. 2.1% in the euro area. To that end, effective interest rate on cash (non-earmarked) loans was 10.4% and that on housing loans was 6.7%, which was com-parable to 6.3% or 2.6% in the euro area, respectively. There is no statistics for Montenegro on interest rates on new deposits, but only on total deposits. The comparison of these data showed that interest rates on deposits in Montenegro were generally 1-2 percentage points higher compared to those in the euro area. In other words, deposit interest rates in Montenegro were more affected by a decline of interest rates in the euro area than lending interest rates.

Divergence with regard to lending interest rates was present also in the euro area countries, particu-larly in loans to corporate sector, primarily due to the difference in general economic position and expectations for the economy of one country. In addition, other factors influenced the differences in lending interest rates: prices of sources of financing, possibility of collection in case on loan default, i.e. legal security, state finances balance, the possibility of use of the economy of scale, the level of bank-ing sector competition or the possibility of alternate ways of funding. Similarly, relatively poor general economic position of the corporate sector and disputable profitability of potential investment projects in Montenegro primarily influence a higher level of lending interest rates than it is the case in the euro area. Some other factors result from or are connected with this factor, such as the prices of sources of financing Montenegrin banks. Relatively worse legal framework for the collection of claims is also an important factor of difference in the level of lending interest rates. Additionally, a small market and high fixed expenses surely hinder the possibility of use of the economy of scale.

3.2. Micro-credit financial institutions

Total assets of micro-credit financial institutions (MFIs) amounted to 49.1 million euros at end-2015 and they increased 28.2% y-o-y.

With regard to MFIs’ assets structure, net loans accounted for the main share (91.5%), followed by cash and deposit accounts with central banks (2.1%) and net other assets, which made up 6.4% of MFIs’ total assets at end-2015.

MFIs loans amounted to 48.5 million euros, being 23.6% higher than at end-2014. Non-performing loans accounted for 8.4% and they declined 3.1 percentage points y-o-y. Past due loans over 30 days made up 9.5% and they declined y-o-y by 3.8 percentage points.

Observed by institutional sectors, almost all MFIs loans were granted to the household sector, while observed by their purpose, loans for the purchase of fixed assets accounted for the main share in the loan portfolio of MFIs (16.6%), followed by consumer loans (15.2%) and cash non-earmarked loans (8.3%)40. Long-term loans made up 79.8% of total loans of MFIs.

40 It refers to loans covering interest receivables and interest/fees prepayments and accruals.

70


As for the liabilities and capital structure, capital accounted for the main share (44.7%) and it amoun-ted to 22 million euros at end-2015. Capital from donations accounted for 80.3% of total capital, while retained earnings made up 9.8% and the current year profit made up 9.9%. On the other hand, liabili-ties made up 55.3% of total liabilities and capital or 27.1 million euros.

MFIs ended 2015 with positive financial result of 2.2 million euros (positive result was recorded at the end of every quarter).

Interest rates used by MFIs for granting loans trended down in 2015. At end-2015, the weighted ave-rage lending effective interest rate (WALEIR) amounted to 24.68% and it declined y-o-y by 0.98 per-centage points. As for the rates on new loans, the WALEIR was 24.55% for loans granted in December 2015, which was 0.07 percentage points lower than the respective interest rates on loans granted in December 2014.

MFIs reported a very modest share in total loans granted and in general in the financial sector’s assets, thus they pose a small risk to financial stability. They do not have a legal possibility of accepting de-posits and there is no danger of jeopardising their financial position through deposit outflow or the effect of spreading panic.

3.3. Capital Market

Capital market developments in 2015 were worse than in 2014. Turnover declined 39.5% y-o-y and it amounted to 65.4 million euros. Average monthly turnover amounted to 5.5 million euros in 2015 compared to 9 million euros in 2014. The main index of the Montenegro Stock Exchange, MONEX,41 grew y-o-y by 6.8%. On the other hand, the MONEX PIF, investment funds’ index recorded a decline of 11.3% in 2015. A new index, the MNSE10, which represents 10 most liquid securities in the Monte-negrin capital market, grew by 4.5% in 2015.

Table 3.1

Core indicators of the Montenegro Stock Exchange developments in 2015

MONEX, 31.12.2015 12.128,07

MONEX, 2015/2014 6.8%

Turnover in 2015, in EUR 65.404.780

Turnover, 2015/2014 -39.5%

Market capitalisation, in EUR, 31.12.2015 2.980.862.314

Market capitalisation, 2015/2014 -0.7%

Source: Montenegro Stock Exchange

41 It is the successor of the MONEX20 which has more companies in its index basket using a new methodology.

71

Financial System

The Montenegrin capital market is still showing numerous weaknesses, the most important being very low liquidity (depth) and poor protection of proprietary rights, especially the protection of minority shareholder’s rights and the observan-ce of basic principles of corporate governance. Issuers’ information on their finances represents a special issue in terms of provision of accurate and regular information. Furthermore, conside-ring the previous assessments and taking into account a precipitating decline of the indices values in the crisis aftermath, a considerable number of investors have lost the confidence in the capital market. However, the assessment re-mains that the share prices of some companies are currently unreasonably below their intrinsic values, which is also undesirable from the aspect of financial stability.

Compared to banks, the capital market in Montenegro traditionally has a relatively small role in the real sector financing, i.e. gathered amounts of capital through the issue of shares in Montenegro are negligi-bly small compared to capital that the real economy borrows in the form of loans from banks. However, this market needs to be developed, and the abovementioned shortcomings and weaknesses should be corrected so that it could contribute more in connecting those with surpluses of financial assets (depo-sitors, investors) with entities which lack financial assets. Thus, the entire financial sector/system would be more liquid and more developed, creating much more space for economic growth. The primary issue of government and corporate bonds in 2014 was a good step forward in that direction.

Annual turnover, 2002-2015 Indices trends, 2014-2015, end of month period

Trend of simple average of indices MONEX 20 and MONEX PIF, period March 2003-2014,

end of month period


Graph 3.27

Source: Montenegro Stock Exchange, Monstat Source: Montenegro Stock Exchange

Source: Montenegro Stock Exchange, CBCG calculations

72


3.4. Insurance Sector42

The increase in gross written insurance premium, increase in total assets and negative financial result marked the developments in Montenegrin insurance sector in 2015.

Total gross written premium generated in the insurance sector amounted to 76.9 million euros in 2015, recording the year-on-year increase of 6.2%. Non-life insurance premiums accounted for the main share (83.2%) in the structure of premiums of insurance companies, in the total amount of 64 million euros. Life insurance premiums amounted to 12.9 million euros and they increased 2.9% rela-tive to 2014, with a slight increase in the share of non-life insurance premiums and decline of the share of life insurance premiums in total premium.

Observing the structure of non-life insurance premiums in 2015, compulsory insurance accounted for the main share (44%), recording a decrease of 2.6 percentage points compared to 201443. In the life in-surance premium structure, life insurance accounted for the highest share of 89.3% and together with supplementary insurance of persons comprised 99.6% of total life insurance premiums.

In 2015, 11 insurance companies operated in the Montenegrin insurance market, of which six engaged in life insurance business, while five insurance companies engaged in non-life insurance, whereby foreign capital accounted for the main share in total capital. According to the Herfindahl-Hirschman Index by gross written premiums, the insurance market concentration increased from 2.041,1 points at-end 2014 to 2,100.6 points during 2015.

The solvency margin of insurance companies was 16.2 million euros while capital amounted to 37.6 million euros.44 Thus the capital to solvency margin ratio in the Montenegro’s insurance sector level was 2.3 (2.5 at end-2014), which indicates that solvency of insurance companies was satisfactory. In addition, total share capital of insurance companies amounted to 53.9 million euros at end-2015. Liqu-idity ratio (liquid assets to short-term liabilities) was 12.6 and it was considerably higher relative to end-2014 when it was 8.4.

The financial result at the insurance sector level was negative and it amounted to 2.7 million euros (compared to a positive result of 4.5 million euros in 2014).

The insurance sector has a relatively small impact on financial stability. As with the capital market, possibilities for market growth should be sought in this market as well. Higher gross premiums and balances of insurance companies mean more money (capital) in the system, since insurance compa-nies are entities which place further a large portion of capital mostly towards other financial inter-mediaries (usually banks) or directly into the market, while providing unavoidable type of financial service. Low income of the population and a rather difficult state of the real economy are stated as the main reasons why the insurance market is not larger, as well as the lack of awareness of importance of services that this sector provides.

42 All data for the insurance sector that refer to 2015 are preliminary data. 43 Compulsory insurance is motor vehicle liability insurance, aircraft and vessels.44 Capital is calculated according to regulations and not as a category from the balance sheet.

73

Financial Infrastructure

4. FINANCIAL INFRASTRUCTURE

A set of institutional arrangements/systems make the financial infrastructure which provides the fra-mework for effective and safe performance of financial intermediation. The following two important segments of the financial infrastructure in Montenegro are examined here: the payment system and the credit registry.

4.1. Payment System

The Central Bank of Montenegro is the operator of the interbank payment system (CBCG Payment System) consisting of two sub-systems, RTGS and DNS.45 Core objectives of activities in this domain are payment system safety and efficiency in functioning, which provide adequate support to the proce-ss of financial intermediation as well as to the resilience of other parts of the financial system.

Table 4.1

CBCG Payment System availability

PeriodWorking Extension

in minProduction

in minSuspension

in minSystem

availability, in %Days Hours Minutes

2011 255 2.165 30 29 129.959 62 99,95

2012 255 2.167 30 15 130.065 86 99,93

2013 254 2.159 129.540 85 99,93

2014 253 2.150 30 129.030 47 99,96

2015 254 2.159 129.540 100,00

I 2015 20 170 10.200 100,00

II 2015 20 170 10.200 100,00

III 2015 22 187 11.220 100,00

IV 2015 22 187 11.220 100,00

V 2015 18 153 9.180 100,00

VI 2015 22 187 11.220 100,00

VII 2015 21 178 30 10.710 100,00

VIII 2015 21 178 30 10.710 100,00

IX 2015 22 187 11.220 100,00

X 2015 22 187 11.220 100,00

XI 2015 21 178 30 10.710 100,00

XII 2015 23 195 30 11.730 100,00

Source: CBCG

45 Basic characteristics: RTGS system: payments are processed individually, in real time, on gross basis and in line with the FIFO principle for large payments (over EUR 1,000); DNS system: used for minor payments, understands multilateral schematics of resuming payables at the net level, while settlement of net positions is done through RTGS system. (There are three clearing cycles per day).

74


In 2015, total output of the CBCG Payment System, i.e. the RTGS and DNS systems, amou-nted to 129,540 minutes, without any suspension of the system; therefore the system availability was 100.00%, continuing the trend of especially high availability recorded in previous years.

In 2015, total executed national payment system transactions amounted to 24 billion euros or 3.7% more in relation to 2014. On the other hand, the number of transactions increased by 8.1%, to 30.2 million transactions. Observing their structure, the value of payment system transactions incre-ased primarily due to an increase in internal payment system transactions (6.1%) and cashle-ss payment system transactions (9%), while the value of interbank payment system transactions increased by a mere 1%. As far as the structure of

CBCG Payment System availability, 2011-2015, %

Graph 4.1

Source: CBCG

Table 4.2

Comparative indicators of volume of payment system transactions, in euros

2015 2014 2013 2012 2011 2015/2014

Interbank 11.119.688.006 11.006.358.207 10.123.092.075 9.103.468.406 9.069.817.107 101,0

RTGS 10.461.014.240 10.407.060.461 9.552.596.535 8.553.655.836 8.519.229.139 100,5

DNS 658.673.766 599.297.745 570.495.540 549.812.570 550.587.969 109,9

Internal 12.907.003.944 12.164.245.660 12.180.126.932 11.710.512.566 12.009.464.651 106,1

Cashless 9.668.478.032 8.871.084.699 8.998.002.178 8.682.132.662 8.952.110.113 109,0

Cash 3.238.525.911 3.293.160.961 3.182.124.754 3.028.379.904 3.057.354.538 98,3

Total 24.026.691.950 23.170.603.866 22.303.219.007 20.813.980.972 21.079.281.758 103,7

Source: CBCG, commercial banks

Table 4.3

Comparative indicators of volume of payment system transactions, number of transactions

2015 2014 2013 2012 2011 2015/2014

Interbank 8.979.882 8.212.730 7.865.980 7.405.773 7.780.970 109,3

RTGS 3.543.746 3.725.929 3.678.688 3.520.051 3.999.616 95,1

DNS 5.436.136 4.486.801 4.187.292 3.885.722 3.781.354 121,2

Internal 21.184.750 19.704.536 18.113.762 16.648.750 15.862.001 107,5

Cashless 15.174.699 13.556.253 12.549.144 11.602.066 10.805.920 111,9

Cash 6.010.051 6.148.283 5.564.618 5.046.684 5.056.081 97,8

Total 30.164.632 27.917.266 25.979.742 24.054.523 23.642.971 108,1

Source: CBCG, commercial banks

75

Financial Infrastructure

volume is concerned, both the volume of interbank and internal payment system transactions increased by 9.3% and 7.5%, respectively. Also, the number of transactions processed in the RTGS system declined by 4.9%, while those processed in the DNS system increased by no less than 21.2%.

In 2015, the Central Bank made an assessment of the compliance of the CBCG Payment System with the principles for payment systems functioning defined in the prevailing regulation in that period46. Based on the risk assessment, a partial assessment of compliance of the CBCG Payment System with the principles for the payment systems functioning was performed - in the part concerning security and operational reliability (Principle 7), efficiency (Principle 8) and governance (Principle 10). It is assessed that the CBCG Payment System was partially compliant with Principle 7, largely compliant with Principle 8 and fully compliant with Principle 10. Furthermore, within its oversight function, the CBCG monitored the status of implementation of recommendations from the previous full-scope compliance assessment of the CBCG Payment System from 2010.

4.2. Credit Registry

The primary objective of the credit registry operating within the Central Bank of Montenegro since 2008, is the gathering of relevant data on retail and corporate loans, all aimed at providing informa-tion which contribute to better assessment and credit risk management in banks. Information obta-ined from banks were initially used in the Central Bank for the purpose of conducting more efficient inspections, while data from the credit registry was later made available to banks and MFIs and, as of 2010, to the Investment and Development Fund. Besides information on loans, banks are also obliged to submit information on all issued guarantees, credit cards, leasing facilities, overdrafts, and other loan receivables that expose a bank to risk.

The report obtained from the credit registry database includes all loan-related obligations that legal or natural persons have with all banks in Montenegro, as well as interest and regularity in repayment, or the quality of repayment of obligations. Contingent borrowings of a client, reflected through gua-rantees or collaterals that the client issued for other legal or natural persons, can be determined based on the report.

Table 4.4

Number of clients by active loans, end of year

2011 2012 2013 2014 2015

Natural persons 104.158 102.212 104.948 106.365 107.316

Legal persons 4.830 4.771 5.241 5.521 5.422

Total 108.988 106.983 110.189 111.886 112.738

Source: CBCG

46 Principles were based on the Core Principles for Systemically Important Payment Systems (BIS, 2001). New principles, contained in the Decision on Payment System Oversight (OGM 48/2014) which came into force on 1 January 2016, are based on the Principles for Financial Market Infrastructures (BIS-IOSCO, 2012).

76


Table 4.5

Number of clients by total receivables (loans, lease operations, credit cards and overdrafts at current accounts), end of year

2011 2012 2013 2014 2015.

Natural persons 146.132 150.260 142.311 143.528 160.131

Legal persons 6.261 6.355 6.926 7.373 7.219

Total 152.393 156.615 149.237 150.901 167.350

Source: CBCG

Table 4.6

Number of searches for the observed period

2011 2012 2013 2014 2015.

198.722 143.990 136.949 135.432 147.260

Source: CBCG

The Central Bank of Montenegro Law of 2010 established the legal basis for further development of the credit registry and its functioning was later regulated in more detail in the Decision on Credit Registry.47 The implementation of this decision, where in addition to monthly, daily reporting on new loans and other exposures of credit and guarantee institutions was introduced as of 1 November 2011, additionally enhanced the quality of information obtained from the credit registry, and simultaneo-usly enabled the issuing of reports to residents – legal and natural persons – on their current and contingent liabilities.

Apart from 14 banks, six MFIs and the Investment and Development Fund (IDF), and based on the contract concluded with the Central Bank, other financial sector participants can be also included into the reporting system (leasing companies and insurance companies), as well as legal persons outside the financial sector with whom legal and natural persons are heavily indebted (electricity distribution companies, tax authorities, and other).

Finally, since the credit registry increases the credit and guarantee institutions’ level of information on credit and guarantees history and position of (potential) clients, and thereby influences better credit risk management, as the main risk in the system, the credit registry consequently makes a significant contribution to stability of the financial system of Montenegro.

47 Until then, the participation in the registry was regulated exclusively by contracts. Law: OGM 40/2010, 46/2010, 6/2013. Decision: OGM 27/2011, 64/2012.

Concluding Remarks

77

5. CONCLUDING REMARKS

Considerations about certain threats and vulnerabilities given in this chapter, as well as in the rest of the Report, are intended to point to threats to the financial system stability. That does not mean that threats will necessarily be realised.


Pressures exerted from the European debt crisis have undoubtedly weakened, while the situation in global financial markets has improved. However, the global economic environment remains uncertain and growth is still not very satisfactory (primarily in advanced economies, with a partial exclusion of the USA). Fortunately, the situation is more positive for the region surrounding Montenegro.

Since a small increase in economic activity is forecasted for Europe in 2016 (the latest official forecast of the IMF for the euro area is 1.7%), Montenegro, being a small and open economy which is directly or indirectly connected to Europe, is not expected to have high growth in 2016 originating from this source. However, Montenegro will be an exception due to capital expenditures for the first section of the highway and a significant expected contribution from tourism. Regarding the channels of influen-ce and bearing in mind the current model of system functioning, the most important channel is the balance of payments financial account (decline in capital inflow/capital outflow). Therefore, both the government and the private sector remain quite vulnerable and dependant, both based on debt and equity investments.

National Macroeconomic Environment

In the period 2009-2015, the Montenegrin economy cumulatively recorded a mild real growth, while a decline in economic activity was primarily avoided due to new public sector borrowings (Eurobond issues and bilateral credit facilities), and, of course, foreign direct investments. A positive growth rate was recorded in 2015, but the state of the real economy has not significantly improved – worrying problems with weak liquidity continued. The household sector is not in much better situation in com-parison to the previous year.

Domestic capital market remains still in deep crisis. The MONEX20 index, as an expectation indicator, although it grew by 6.8% at the end of 2015 relative to end-2014, is still trending downward, more than 75% in comparison to the boom from the spring 2007 (in a situation when some of the global indices completely recovered or even surpassed their pre-crisis values).

The CPI prices increased by 1.4% in 2015, if compared to the decrease in prices of 0.3% in 2014. The growth in prices was mostly due to the growth in prices of the products from the category food and non-alcoholic beverages (due to the growth in prices of oil and fats, fruits, meat and vegetables) and categories clothing and footwear and housing, water, electricity gas and other fuels. On the other hand,

78


only category transport declined by 4.6% due to a drop in the prices of fuel and lubricants by 11.1%, which was basically the only factor with a negative impact on the inflation rate.

As for expectations in 2016, Montenegro will certainly be exposed to the global price movements, with the largest influence of food and oil prices. Nevertheless, the IMF forecasts deflation trends at the global level (on average) in 2016, thus there should not be pressures to growth of prices in Montenegro from this side even though this type of forecasts are uncertain.

As already pointed out, trends in the balance of payments are perhaps the indicator of the most signi-ficant imbalances in the Montenegrin economy. In 2015, the current account deficit was lower in com-parison to 2014 (the deficit decreased by 8.3%, and its share in GDP fell by 1.8 percentage points), while the coverage of import by export declined by 2.4 percentage points and amounted to a mere 18.2%. As for the structure, a decrease of the current account deficit is mostly the result of the increase in surplus in the services account and in the primary income account, while trade deficit increased by 6.3%. On the other hand, net FDI inflow was higher by no less than 75% if compared to the previous year and it was 619.3 million euros or 17.2% of GDP, while net inflows to the capital and financial account as a whole reported a mild decline and accounted for 3.3% of GDP.

It is estimated that the budget deficit amounted to 8.1% of GDP in 2015, largely because of increased ex-penditures for capital budget. Moreover, debt repayment amounted to 541.7 million euros (the amount that is not included in the deficit). The 2015 deficit, was quite higher than in 2014; thus the average deficit in the period 2009-2015 was at the level of around 5.4% of GDP. Deficit planned for 2016 is 7.2% of GDP.

The deficit consequently increased the net public debt, which was 2.2 billion euros at end-September 2015, of which 1.98 billion euros referred to external debt. Furthermore, issued guarantees (foreign and domestic) amounted to 305.4 million euros. The public debt is still not too high in relation to GDP; however, the continued debt-growing trend and an aggravated provision of sources for its repayment are the matters of concern. At end-September 2015, the share of net public debt in GDP amounted to 59.8%, while the share of guarantees was 8.5% of GDP48. High vulnerability of the private sector should be added to this, which taxation provides the funds for debt repayment.

Government borrowing certainly prevented contraction of the economic activity in the period 2009-2015, but the budget has to be balanced after the completion of the highway construction, and until then, it should strive to have a balanced structural budget.

According to Monstat, an average price per square meter in a new building was 1,090 euros, i.e. 0.1% more than in 2014 (3.8% higher in Podgorica), while a new-building apartment sale increased by 9.5% (growth of 11.5% in Podgorica). The results of the September CBCG Survey showed that the average real estate price per square meter in Podgorica amounted to 939 euros, which is an increase of 1.97% if compared to March 2015. It is assumed that a slight revival of the real estate market will occur in the following period through the process of adjustment of supply against demand due to the expected growth in available income, „1000+ apartments“ programme and a potential growth of FDIs in real estates. The course of realisation of important tourist and infrastructure projects in Montenegro in the following period will positively affect the revival of the construction sector. Growth in banks’ lending

48 According to the baseline scenario form the Economic Reform Programme for Montenegro (Government of Montene-gro), debt will amount to 2.74 billion euros at end-2016 or 70.7% of GDP.

Concluding Remarks

79

activity is expected in the following year as well as a decline in lending interest rates, which could par-tially contribute to the revival of the real estate market. On the other hand, although a slight recovery of the real estate market is estimated in 2016, this segment of the economy still represents a potential source of risks if the stagnation or further decline in prices would occur as a result of extremely low enforcement of purchase agreements, stagnation in real wages and salaries, unexpected further unem-ployment growth or the Russian Ruble devaluation. Namely, citizens of the Russian Federation who are owners of real estate in Montenegro could decide to cash out their immovable properties, by incre-asing an already high supply, which would result in a further decline of prices. However, it is estimated that this risk is not high at the moment.

Financial System

In general, the banking sector experienced further consolidation during 2015. Banks have further increased financing from deposits (mainly domestic) if compared to borrowings (mostly foreign). De-posits recorded an annual growth of 13.7%. Liquid assets grew as well. Total assets thus increased by 10.7%, while loans slightly increased by 0.8% at end-2015 relative to end-2014, which further reduced the loans to deposits ratio. However, the system-level loss was 3.4 million euros (with losses of five banks) against 23.8 million euros profit in 2014.

Despite improvements, the problem of the loan portfolio quality is very pronounced. The share of non-performing loans, i.e. the shares of 30-day and over past due loans in total gross loans declined in relation to end-2014, but they were still high, 12.6% and 14.8%, respectively. Furthermore, the value adjustments for non-performing loans to non-performing loans ratio amounted to low 39.5% same as at end-2014. Similarly, net non-performing loans are still high compared to capital (42.5%), although a significant improvement was recorded in this part in the past several years. Finally, stress testing showed that some banks are still very sensitive to credit risk.

Liquidity of the banking sector is satisfactory. Stress testing showed inadequate liquidity in several banks in case of potential high deposit outflows; however, it should be borne in mind that the tests used are rather rigorous, as well as that a relatively narrow definition is used of readily available/avai-lable liquid assets which would serve to cover outflows.

Stress testing also showed that interest and FX risks are negligible, both at the system level and at in-dividual bank levels.

As for the capital market, 2015 was much worse than 2014, primarily in terms of turnover. Total turno-ver was 39.5% lower in relation to 2014, and it amounted to 65.4 million euros (mainly due to the pri-mary issue of the government bonds and bonds of one commercial bank in 2014). The MONEX index grew by 6.8%, while the MONEX PIF declined by 11.3% during the year. However, certain substantial defects of the market are still present. Furthermore, it seems that a certain number of shares was still underestimated, which is undesirable from the aspect of financial stability. In addition, individual perceptions of personal wealth moves downward unrealistically causing the contraction of their con-sumption and, consequently, the general level of economic activity.

As for the insurance companies position, the preliminary operating results show that this sector grew further in 2015 although accompanied by a negative financial result. Relative size of this sector conti-nues to be a limiting factor for its potential impact on the rest of the financial system, i.e. on the real

80


economy. Nevertheless, a larger and stronger insurance sector would be desirable: it would mean more capital in the financial system.

Schematic 5.1 shows the key risks.

Schematic 5.1: Key risks and directions of influence

Concluding Remarks

81

5.1. Policies for preservation of financial stability

Real Sector / Balance of Payments

The real/private sector remains very vulnerable. Only a strong and competitive private sector enables stable state finances, does not threaten the banking sector (which is exposed to it), and provides jobs and personal earnings for the household sector.

It is necessary to work on building the private sector on a sound and competitive basis and on the principles of comparative advantages. Montenegro has comparative advantages for the development of tourism, agriculture/food industry and energy industry – and those sectors should be recording significant surpluses in foreign trade. This would lead to the balancing of the current account, which is, as it seems from the current period of global instability, a desirable and normal condition for ma-intaining economic activity through borrowing or inflows for real estate. Firstly, because capital flows are rather sensitive to instability occurrence and, secondly, because capital inflows (whether debt or equity) cannot last forever.

Debt does not have to be bad in all circumstances; however, artificial maintaining of standard throu-gh debt is undesirable. The situation is similar with capital inflows: the best are those through which the situation has essentially changed for the better, and where capital is used for production and not consumption purposes. This has not been the prevailing practice in Montenegro so far, when it comes to capital inflows, both in terms of real estate trading (households) and in terms the selling of state-owned companies (privatisations). Undoubted appetite for capital/higher standard in the household sector and certain real problems the government was facing only partially justify this situation. One form of equity investments needed in Montenegro is Greenfield investments (ideal for import-oriented activities), so far under-represented. However, it should be noted that the (announced) construction of luxury tourism facilities on the coast would rather improve this situation.

Although the private sector should make a turn towards the abovementioned activities, the support from the government is unavoidable. The State needs to provide a stable and predictable environment (legal, administrative and judicial) and in communication with the private sector, to create an umbre-lla strategy of economic development, which will be gradually implemented afterwards.

Fiscal Deficit (Surplus) / Public Debt

The government sector will bear risks in 2016 as well. In that sense, the measures of fiscal consolida-tion from 2013 and 2014 are very encouraging as well as certain savings on individual current expen-ditures positions in 2015, while a decline in the budget revenues and an increase in certain current expenditure positions remain a matter of concern as well as the increase in expenditure for capital budget in 2015. We can see how excessive debt can become a factor of limitation of growth and pros-perity in case of the neighbouring and EU countries.

The Government of Montenegro expects the fiscal deficit to be somewhat lower in 2016 than in the previous year. It would be desirable also to stop the public debt growth trend but that cannot be reali-stically implemented in the coming year, primarily due to borrowings for the construction of the first

82


highway section. The adoption of the Law on Budget and Fiscal Responsibility in 2014 was also a solid step toward the establishment of a tighter fiscal discipline.

The financial markets may see further increase of the public debt and a high fiscal deficit as factors which may threaten regular financing of government obligations. In such conditions, capital inflows are interrupted or significantly decreased, portfolio investors withdraw, risk premium increases (pu-blic debt financing becomes more expensive), credit rating is downgraded, the banking system ope-rations are threatened, etc. However, it should be borne in mind that the level of Montenegro’s public debt is lower than the average in the regional countries and the EU member states. Furthermore, the global financial crisis affected the readiness of the financial markets to accept the increased level of public debt. The question of guarantees is inevitably brought together with question of the debt itself: issuing new guarantees must be applied very restrictively, which was significantly improved in the period 2012 - September 2015.

Banking Sector and the Rest of the Financial System

The banking sector acquired a painful, but precious experience from the pre-credit boom and later from the period of recovery from its consequences. However, this period is not over yet and the banks need to continue to clean their balance sheets with all means available: sale, restructuring and finally write-offs. Certainly, adequate policy of impairment remains inevitable in credit risk management. In addition, all possibilities for borrowing and recapitalisation need to be examined in advance. The Cen-tral Bank will monitor all these processes and it will continue, within its possibilities, to support the banking sector. Since the CBCG manoeuvring space is narrowed down due to euroisation, therefore the most important lever is undoubtedly the banking supervision. Although the concept of financial stability and macroprudential inspection defers from microprudential approach, an efficient banking supervision is the key for achieving financial system stability because prevention is the best policy.

Aside improvements reflected through trading in government and corporate bonds in 2015, the capital market must further strive towards higher transparency (especially in regular disclosure of accurate financial statements of issuers, as well as information on business activities of all other market par-ticipants: the stock exchange, brokers, etc.), a stronger protection of proprietary rights (primarily of minority shareholders), and the promotion, support and protection of core principles of corporate governance. The insurance sector also requires an increase in the level of transparency as well as rein-forcement of supervision. Furthermore, it is necessary to intensify efforts to promote the significance of services provided to the society by insurance companies.

CIP - Katalogizacija u publikacijiCentralna narodna biblioteka Crne Gore, Cetiwe

336(497.16) (060.55) (047)

FINANCIAL Stability Report 2015. -2011- . - Podgorica (Bulevar Sv. Petra Cetinjskog 6) : Centralna banka Crne Gore, 2016 (Podgorica: Studio Branko d.o.o. Podgorica). - 28 cm

GodišnjeISSN 1800-8941 = Financial Stability Report (Podgorica) COBISS.CG-ID 18454544

financial stability report 2015 - · pdf file7 introduction financial stability report 2015...

Documents