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ECONOMY WB’s Paolucci: Authorities to focus on economic measures as pandemic-hit economy is recovering

GDP in 2021 should turn positive to 3.6 percent assuming no new lockdowns and no new COVID-19 outbreaks in the coming winter and spring, according to Massimiliano Paolucci, the new World Bank (WB) Country Manager in Skopje.

In an interview with MIA, he notes that the speed and intensity of the recovery will depend on the duration and spread of the pandemic, distribution of vaccines, as well as on the steps that policymakers will take to address structural weaknesses.

“Economic and social measures to remedy the crisis will have to be the main priority for the authorities,” he says.

The government, Paolucci says, responded quickly by implementing interim measures to support companies (such as soft loans, tax deferrals, ad-hoc support for specific sectors), protect jobs and help those most in need.

“The World Bank has been a committed partner to the Government of North Macedonia for more than 25 years,” its official stresses adding the World Bank Group so far has invested over US$2 billion in North Macedonia.

Following is the interview in full:

You are the new Country Manager for the World Bank in Skopje. What are your estimates on the economic situation in the country?

I took over this position in the middle of the COVID-19 crisis, with the country facing the far-reaching consequences of the pandemic and uncertain prospects of a sustained recovery. Before the crisis, the economy had been doing well with growth above 3 percent led by investments and consumption, and public finances have been stabilized after years of high deficits and rising debt.

North Macedonia is coping with its deepest recession since 2001. The robust 3.2 percent growth of 2019 was reversed by mid-2020 as the pandemic unfolded. A lockdown, disrupted supply chains, and a prolonged adverse epidemiological situation throughout summer darkened an already dim outlook. By June growth was down by 6.4 percent: manufacturing had dropped by 16.1 percent with growth in only a handful of areas. Trade, tourism, and transport, which have been driving growth for several years, together fell by 12.3 percent—tourism simply came to a halt. High frequency and sentiment indicators suggest the recovery of trade starting in July, when the economy reopened, will be very slow; industrial production is still down some 9 percent. Growth was mostly observed in public sector, agriculture and ICT.

Such a shock led to layoffs of workers and a rise in unemployment, which was cushioned by the Government job retention subsidy and social protection measures. However, this had an adverse effect on fiscal accounts, which combined with declining revenues is set to push the fiscal deficit over 8 percent of GDP, after the fourth package of government measures is taken into account. Public debt is now projected to exceed 60 percent of GDP by end-2020.

Six months passed since the beginning of the crisis in the Republic of North Macedonia. Do you remain on the primary projections related to the GDP growth for this year and what are the prospects for the next year?

The fluidity of the situation does not make easy to forecast GDP movements in a precise manner. What we can say is that the downward trend of GDP has been exacerbated by the persistence of the pandemic and may be in part reversed when the pandemic starts to ease. With that in mind, we have initially expected that the recovery would resume in July. However, the prolonged adverse epidemiological situation and containment measures well into the summer caused further demand contraction and supply chain disruptions, including closure of factories. The second COVID-19 outbreak has darkened the outlook because it has disrupted production, while, at the same time, social distancing has been limiting consumption. GDP for 2020 is expected to contract by 4.1 percent (or 4.6 percent in light of the recent revisions of historical GDP), and may drop further if new lockdowns are enforced in response to increased infection rates.

The near-term outlook is positive but with heightened downside risks: the containment phase has not yet finished, and a longer period of social distancing policies will affect firms, household incomes, and spending on health.

Over the medium term, growth is expected to return as the pandemic loses force. The political stability after the general elections, together with the launching of the EU accession negotiations are expected to boost both reforms and investor confidence so that once the crisis is over, growth rebounds faster. Assuming no new lockdowns and no new COVID-19 outbreaks in the coming winter and spring, GDP in 2021 should turn positive to 3.6 percent. Nevertheless, the speed and intensity of the recovery will depend on the duration and spread of the pandemic, distribution of vaccines, as well as on the steps that policymakers will take to address structural weaknesses. Economic and social measures to remedy the crisis will have to be the main priority for the authorities. However, due attention would also need to be given to the implementation of fiscal, competition, environmental, and governance reforms in order to promote economic recovery and fiscal stability, while advancing in the EU accession process.

Are policies and measures taken by the government enough and do they give results and will the economy manage on longer term with COVID pandemic?

The government responded quickly by implementing interim measures to support companies (such as soft loans, tax deferrals, ad-hoc support for specific sectors), protect jobs and help those most in need. Subsidy schemes aimed at employment retention have cushioned the impact of the containment measures and helped preserve jobs, as evidenced by the relatively mild increase in unemployment by mid-2020. Social protection schemes in place have also helped protect the most vulnerable, although, as in many other countries around the world, we could expect an increase in poverty rates due to lower labor incomes and remittances.

The measures that the Government implemented were coordinated and complemented by the ones put forward by the Central Bank. The stable financial sector and adequate level of foreign reserves gave the Central Bank enough room to support the economy. More specifically, the Central Bank has implemented a number of measures to mitigate the immediate impact on companies by temporary changing the credit risk management regulations; allowing banks to restructure loans; boosting liquidity of banks by lowering the amount of treasury bills issued; and supporting lending activities by reducing the key interest rate which limited the rise in borrowing costs. Credit growth during pandemic even increased for companies and households.

Going forward the domestic financial sector should be in a position to support the recovery as the banking system in the country is stable, well capitalized and profitable. The capital adequacy ratio is double the mandatory requirement and liquidity in the system is high, which should provide banks enough room to expand their lending activities. It is important that the authorities continue implementing policies that will further strengthen the resilience of the system, such as enhancing the existing legal framework for bank resolution and crisis preparedness, further strengthening the deposit insurance system, improving the corporate insolvency framework, and introducing a modern financial consumer protection framework.

Economic measures that Government adopted before and the one that will be implemented with the fourth package are to support the economy and for keeping the jobs, but how do you estimate the measures addressed to the citizens with payment cards and can all these measures be financed; will it create pressure on public debt and possibility for its management?

In the design of the measures one needs to be aware of the available fiscal space and the trade-offs between short-term mitigation measures and long-term support. While providing short-term mitigation measures that bridge the liquidity of affected firms, policy makers should also keep some space for the recovery phase, as support will also be needed in the medium term.

Putting public finances back on a sustainable path will require a significant effort both on the expenditure side to minimize the unnecessary spending, expand the revenue base, but also on the borrowing side to cover the growing financing needs.

In the current tight fiscal environment, the Government should consider to prioritize expenditures by cutting non-priority spending, focus on less complex fiscal measures that are well targeted, implemented in a transparent manner and timebound. This will provide space for higher capital spending over time, which should be supported by improvements in public investment management procedures.

The immediate revenue shortfall caused by the declining economic activity as well as tax deferrals is compounded by accumulated systemic weaknesses, such as low tax rates, significant tax exemptions and inefficiencies in revenue collection. In light of that, boosting revenues becomes essential, noting that the country has one of the lowest revenue to GDP ratio in Europe and the Western Balkan region. This can be done through strengthening the revenue administration to clap on the informal economy and ease compliance, rationalizing tax exemptions and reviewing tax policy whereby environmental taxation is comparably quite low compared to social security contributions.

In terms of financing, the Government has been pro-active this year and has secured the financing needs for 2020; however the crisis is still far from over and there are sizable financing needs for 2021, both for repayment of maturing loans and bonds and for possible continued support of the economy.

Going forward, while mitigating the near-term impact of the crisis remains the main priority, in order to boost its potential North Macedonia will need to resume its focus on structural reforms once the crisis is over. Boosting inclusion and productivity will require strengthening public institutions that protect the rule of law, while preserving private sector competition, judiciary reforms, addressing skills mismatches and improving public services to boost human capital. In essence, reforming the public administration, strengthening public investments management, and streamlining management of state-owned companies would directly support private sector productivity while also promoting fiscal prudence.

Such combination of structural reforms would help unlock stronger, more equitable, and more sustainable growth, and thus ensure faster convergence with EU income levels and more resilience to any future external shocks.

The World Bank is supporting the implementation of many projects in the country. What is the amount of the current support and when the funds will be available designed for COVID assistance?

The World Bank has been a committed partner to the Government of North Macedonia for more than 25 years. Since the first loan, the World Bank Group has invested over US$2 billion in North Macedonia, implementing projects and providing technical assistance in various sectors, including energy, agriculture, education, roads, health, social policy, innovation, and macroeconomy.

Last year, the World Bank approved the 4-year Country Partnership Framework for North Macedonia, which aims to support the country in achieving inclusive and sustainable growth and create greater opportunities to improve citizen’s living standards and accelerate income convergence with the European Union.

Today more than ever, our commitment to the people of North Macedonia is strong. We have provided both funds and technical assistance to weather the immediate consequences of the pandemic and are determined to work hand in hand with the authorities, with the private sector, with the people of North Macedonia and with other development partners to accompany the country as it responds to the pandemics and implements its recovery plans. In the past months, we have approved a EUR90 million COVID 19 project and we hope it will be soon ratified by Parliament, given its importance to address the health and social consequences of the pandemic. This project has two components. The first component will allow the country’s capacity to detect, prevent, and respond to COVID-19, while strengthening the country’s national health system. The second component will provide temporary income support to eligible individuals and households economically affected by the protracted containment measures.

We have also made EUR37 million in contingency financing from the Local Roads Connectivity Project to support the Government to provide temporary relief to viable small and medium enterprises and cover 50% of the social contributions for the employees of viable firms in the most affected sectors by the crisis, such as tourism and transport.

Pension reforms are announced. Retirement age for women is 62 and 64 for men. What is your opinion on this reform?

Indeed, the public debate has been intense, but, to date, we have not seen any specific proposal. For that reason, my comment is based on what is of public domain and what we have observed around the world. Experience in other countries show that banning or hardening employment beyond already low retirement age of 62 for women and 64 for men, reintroducing early retirement abolished more than a decade ago, and allowing the service period purchase would inevitably cause earlier exit to retirement.

Moving towards longer period of retirement in comparison to work years will be costly and could only be financed by imposing higher pension contribution rates, increasing or introducing new taxes to support pension payments or lowering future pensions. These are all measures that are not popular and that have traditionally encountered strong opposition when passed. Not surprisingly, countries around the world have been opting to proportionally prolong the work periods, often automatically. North Macedonia’s pension system faces the same challenge. A reversal of policies adopted in the past could put additional pressure on the domestic pension system. There is also another aspect in this debate that needs to be taken into consideration. Where adopted, lowering the retirement age has often been justified with the argument that it would have a positive impact on job creation, particularly for the youth. Evidence at the international level shows that this has not always been the case (in economic terms, this paradox is known as “lump of labor fallacy”). More specifically, when comparing the structure of outgoing jobs with newly created ones and the skills and knowledge required, a whopping 75% are incompatible. Releasing old workers does not always and automatically translate in new jobs for the youth.

Regarding education, in the latest report, the estimate was that reforms implemented in the last 10 years do not give result and that children do not receive adequate education. Does it mean that the nine-year elementary education hasn’t been producing the needed results? What should be done in order to improve the overall situation?

The World Bank’s 2020 Human Capital Index shows that children born in North Macedonia today will be 56 percent as productive when they grow up as they could be if they enjoyed complete education and full health. North Macedonia’s Human Capital Index is lower than the average for its region and income group. Poor educational outcomes largely explain this loss of lifetime productivity. While access to primary education has improved in the last decade, the quality of education remains a challenge.

North Macedonia’s results from international student assessments (most recently PISA) reveal comparatively weak levels of student achievement at end of lower secondary grades, suggesting that learning deficiencies which start in primary education persist through later grades. While the country had the greatest improvements in results of any developing countries in PISA 2018, these results are modest and remain well below the mean scores for the EU and the OECD group of countries.

The COVID-19 pandemic has the potential to worsen the situation if not buffered by adequate policies and learning recovery measures. In the early stage of the pandemic, distance learning measures were put in place fairly quickly after the physical closure of schools, but the pandemic revealed that the Macedonian education system is facing a myriad of preexisting issues to going digital: including, access to broadband connectivity, particularly for marginalized and low-income populations, and low ICT adoption.

Education reforms need to address residual problems in both quality and inclusion. Because skills formation starts early in life, and education is “path-dependent” (poor performance early in life excludes many future options), providing higher quality of education right from the start and a more equitable access is necessary to ensure better employment outcomes of the young people.

Macedonia has recently undertaken important reforms of the preschool education and care system. To capitalize further on this important investment, the country needs to invest more and effectively in quality of teaching and learning environment in primary education. To this end, the government would need to make more targeted efforts to improve the access to primary education and support in learning of the disadvantaged groups, improve its system for professional development and career advancement and create a stronger framework to monitor and evaluate national progress in education. However, schools need to be at the center of the reform agenda with aim to ensure quality learning in basic education for all.

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