Statement of the IMF and World Bank staff at the Informal Donor Meeting for Kosovo, Brussels, July 28, 1999

We would like to update donors briefly on a number of key economic policy issues and plans for institutional development, based on work in Kosovo of the recent joint mission and follow up technical assistance teams.

1.  Currency arrangement

We have been discussing policy issues relating to Kosovo with the UN and other partners for a number of weeks. Nothing that we observed during the mission altered our recommendation that UNMIK should use the DM as the primary transactions currency in Kosovo--without, however, issuing any legal decisions or decrees about the currency arrangement of Kosovo. Yugoslav dinars are widely used for small transactions but the DM is preferred, and the parallel local structures are reportedly taking steps to discourage the use of dinars. For the near term, the main policy issue we see for UNMIK is that, since the dinar is the legal tender of the FRY, UNMIK will need to take a decision on whether this means that it is obligated to take dinars in payment of obligations to it. It would be awkward if this were the case, since it would involve UNMIK in statements about the exchange rate of the dinar.

2.  Payments system

We investigated ways to shift from the present, entirely cash-based economy to something more normal. Our judgment is that for the immediate future, the scope for this is limited. The commercial banks are in dire straits. Extensive discussions with the payments bureau head office and Pristina branch confirmed that the payments bureau has become virtually inoperative. It is set up to operate as an integral part of the payments system of the FRY and, since telecommunications links are cut, it has only a minimal capacity to carry out even that function. Moreover, the computer system of the payments bureau is obsolete and neither it nor the software are Y2K compliant. Thus, reviving the payments bureau would be a major, time-consuming undertaking and we see no particular benefit in doing so.

Therefore, we worked with Pillar 4 of UNMIK on plans for an interim cash-based payments mechanism, to provide a more efficient and secure way of handling cash transactions. This system of "cash depots" will serve initially as the revenue collection and expenditure management system for the civil administration, and could be expanded to accommodate transactions by firms and private citizens, until banking services are available.

On present plans, there would be five district "cash depots," one for each UNMIK administrative district, plus a headquarters in Pristina. Within Kosovo, shipments of banknotes would take place among the cash depots, as necessary, to meet the expenditure needs of the civil administration, turning them into an interim treasury system. The headquarters of the cash management system would keep track of balances at all cash depots and arrange for these shipments. All transfers of cash among the cash depots will be accompanied by a KFOR escort. Although most of the follow up action is with Pillars 2 and 4 in Kosovo, we will be providing further technical assistance to UNMIK to help implement this plan, and—as will be described by Mr. Mitra—on broader financial sector issues.

3.  Fiscal issues

As noted earlier today, KFOR has been playing a major role in restarting utilities in Kosovo and providing basic social services, along with humanitarian agencies and NGO’s. The interim civil administration has now begun its efforts to establish sustainable structures.

The Bank and Fund provided technical assistance to Mr. Dixon in his efforts to prepare an initial budget for the civil administration in Kosovo, as well as to assess local capacities and priorities for further technical assistance. Two members of the team that did this work, from the Fund’s fiscal affairs department, are still in Pristina and will be leaving at the end of this week. The Bank and Fund will provide further TA in these areas, beginning in mid-August.

Revenue estimates are extremely tenuous. The are no recent statistics on the possible size of the tax base and no functioning revenue administration exists at any level in Kosovo. Mr. Dixon’s revenue estimates reflect a structure based almost entirely on the collection of tariffs, excise, and sales taxes on imported goods. However, UNMIK would also intend to initiate an inland revenue effort, focusing initially on major service providers—large hotels and restaurants—and has requested urgent technical assistance from the Fund in tax administration.

The draft budget embodies a great deal of work with UN agencies, KFOR, NGO’s and local experts on expenditure issues. The budget is primarily oriented toward delivering essential public services. It covers about 47,000 local employees, of which more than half are in the education system, another 20 percent are health workers, and 15 percent work in public utilities. The budget also provides for a small monthly benefit for pensioners and payments to widows, orphans, and war invalids; overall we estimate there would be about 72,000 beneficiaries of social transfers.

The emergency rehabilitation of the customs administration is being managed by the EU, in consultation with the Fund and Bank, as has been the case in Bosnia and Herzegovina. The customs administration will begin with three border posts, one on the border with Albania and two on the border with Macedonia. These posts would assess the customs duties and other taxes due and, in some cases, collect these amounts from importers. However, the intention would be to operate as much as possible on the basis of advance deposits against future tariff and tax liabilities, to minimize the amount of cash handled at border posts. All importers will be required to be registered with the customs administration, which would assign each importer with a unique registration number. Advance deposits could be made either directly at a "cash depot" or through a foreign correspondent bank. These advance deposits would need to be made at least 48 hours before the import reached the border. There would also need to be provision for registration and payment upon arrival at the border. To strengthen incentives for advance registration (and to reflect the higher cost), a premium of 5 percent will be levied on cash payments at the border.

4.  Banking system

In the pre-war period, Kosovo participated in the banking and payments institutions of the rest of the Republic of Serbia. The banking and payments linkages with the rest of Serbia are now severed. The two-odd local commercial banks functioning today are severely under-capitalised, clearly illiquid, with asset quality likely to be poor. There is no system at present of licensing banks, nor of supervising their activities and balance sheet. The key need of an immediate character is to develop a system for fostering non-cash payments using banks for the use of key public administration activities and the general public. It is also necessary to establish a system of licensing banks and foreign exchange dealers and to establish minimum regulation and supervision.

Once the immediate needs are met, attention should shift towards developing intermediation functions for channeling donor-funded credit lines, donor local cost financing of projects, and provision of small scale banking services to the donor and local population. Deposit taking activities could then follow and commercial lending grow in gradual steps. The extent and rapidity with which banks would be willing to extend commercial credits will depend greatly on progress with the private sector development framework (property rights, collateral, and the like).

The recent Bank-Fund mission agreed with UNMIK (Pillar 4) that a small unit within Pillar 4 be set up to exercise surveillance over banks, before putting in place a system of formal supervision, and the capability to close banks as well as license new banks. The previous system of bank licensing and supervision was run directly from Belgrade and little is left of the independent arrangements for bank supervision that existed in Kosovo until 1989.

Vigilance is also needed to prevent informal banking and possible fraud. Particular attention will have to be paid to generating confidence among the public, given the poor history of Yugoslav banking. The role for existing banks and for possible new ones will have to emerge within this regulated framework. Within this framework, the emergence of non-bank institutions, such as rural credit/savings associations, micro-credit institutions, cooperatives, under a strong supervisory regime, should be encouraged.

5.  External trade

It is desirable that Kosovo’s trade regime be WTO-consistent and harmonised with EU policies and institutions. The transition to such a regime will, of course, take time. During the initial period of Kosovo’s recovery from war, most imports will be donor financed. For commercial imports, an across the board tariff of 10 per cent will be applied; this will help ensure compliance and will be administratively simple. A range of quantitative restrictions and other discretionary restrictive acts of the pre-conflict trade regime will be abolished.

It is UNMIK’s intention to establish a customs administration service rapidly to implement this trade regime and to prevent imports banned on safety, health or environmental grounds from taking place. An EC sponsored technical assistance mission has made important recommendations to this end. The customs administration was a rare service in that Kosovar Albanians continued to be employed in responsible positions and these individuals seem to possess requisite skills and a strong willingness to return to their duties. The early re-establishment of a customs administration, thus, appears feasible.

The customs and trade administration would be the point for the collection of excise duties on a list of high value items, generally identified as imported tobacco and tobacco products, coffee, oil and oil products, imported alcohol, and vehicles. Excises would constitute the most significant source of local revenues, especially in the early stage of economic recovery.

The longer term thrust of trade policy should be directed at regional cooperation and progressively greater integration of Kosovo into Europe on the basis of a private market economy. Policies and institutions should be consistent with EU plans concerning the incorporation of Balkan economies into an emerging European free trade area in industrial goods and other goods and services.

6.  Private sector development

Fostering rapid private market growth is vital in the immediate post-conflict period for job creation and growth and in the long run for economic sustainability. The Bank-Fund mission found a general consensus that Kosovo’s development had to be private sector based. The legal and regulatory environment affecting business would have to be reformed with key outstanding issues being property rights, including changes in ownership over the past decade and some privatisations and foreign concessions, contracting and collateral laws and general business regulations.

The future ownership and management of the large mining, energy and manufacturing enterprises and, indeed, their viability under competitive world market conditions are immediate issues. An examination of the state of enterprises is being undertaken by a number of donors (Bank, EBRD, USAID). This will be followed by the design of business plans covering marketing, technology, and other factors of comparative advantage for a select number of enterprises. On this basis, private investment (strategic, foreign) would be sought for a quick re-start of these enterprises.

Two immediate issues come to mind as needing resolution before sustained investment can begin. First, ownership. The large enterprises were state-owned and the medium and small ones socially-owned under the Yugoslav system. Post-1989 Kosovo saw the forcible integration of Kosovo enterprises (and banks) with "partners" from the rest of Serbia, the awarding of ownership rights or concessions to certain foreign enterprises, and a general loss of management control by Albanian Kosovars in Kosovo’s enterprise sector. The legal validity of these types of transactions under constitutional or company law or under fair competition or transparency requirements is open to question.

Clearly, private investment – foreign or domestic – will be deterred by the uncertainties associated with ownership and it will not be possible to begin a privatisation programme under such conditions. UNMIK has indicated that it would seek legal guidance on ownership and would then issue a decree on ownership that would, in effect, constitute the law of the land on this question. Investment and privatisation could then proceed.

Secondly, support for the emerging private sector. An aggressive programme of SME development is required. Various aspects of the legal and regulatory environment will have to be adapted to this end. Small business support projects would be needed. Given the collapse of the banking system, donor-supported credit lines for working capital would also be essential. Kosovo appears, however, to have access to significant diaspora financing for investment and this may well turn out to be the key to the rejuvenation of its private market based economy.

7.  Need for budget support funds

The programme of economic recovery and reform outlined in these remarks would be UNMIK led , with the Bank and the Fund playing a strong advisory role and the Bank providing finance for the budget, for private sector development and for investment projects. As the UNMIK representative has made clear in his statement, the budget for local costs remains substantially under-financed. The major categories of local expenditures relate to salaries, cost of essential goods, and much needed maintenance operations in the health, education and civil administration sectors. The last-mentioned includes public utilities.

It is natural that the revenue base in the initial stages of post-conflict recovery is small. Revenues will be built up as the economy recovers and as user charges on public services (water, electricity, heating) are levied at increasingly cost-related tariffs. The Bank and the Fund staffs strongly endorse the call made by UNMIK for donor support for its budget to finance the kind of expenditures indicated. The UNMIK estimate indicates that the budget gap for the rest of 1999 amounts to approximately DM80 million or US$45 million. This donor financing need for the budget will begin to fall from the end of the year and can be expected to be much smaller on an average monthly basis in the year 2000. We, therefore, hope that donors will make commitments for budget support.

8.  Strategic Directions for Kosovo’s Economic Recovery

The Bank has circulated a paper on this subject this morning. It is intended to provide a measure of the dimension of the task of economic recovery based on not only physical war-related damage, but also the requirements of transition to a market economy and the institutions that have to be developed to this end and the legal questions on ownership, sanctions and applicability of FRY law that have to be resolved. The paper also sketches the framework of a priority recovery programme focussing on promoting a private market economy, jump-starting agriculture, rehabilitating infrastructure and strengthening key government services in the social sector.