UNMIK has made impressive progress in building the bedrock institutions necessary for economic recovery in Kosovo. Out of the chaos, UNMIK has fashioned a well-functioning and transparent Central Fiscal Agency (CFA), a working payments system, and a regulatory framework for banking and private enterprise. However, there is still a long way to go. The industrial sector of the economy remains very weak, only two private banks are operating, tax sources and instruments are inadequate, and income levels are very low. IMF estimates that per capita GDP in the year 2000 was only $750 which is below the levels in neighboring Albania and Bosnia and Herzegovina.

Progress is particularly noteworthy in the area of budget preparation and execution. UNMIK has developed a sound structure for processing expenditure requests within realistic budget constraints. The 2001 budget is a culmination of this process. IMF staff have worked closely with the CFA in analyzing tax policy and revenue prospects, and agree that the budget revenue target is attainable. At the same time, planned expenditure levels are not excessive neither in view of the considerable social and economic needs, nor in comparison with levels in low-income countries. As a result, UNMIK has kept its commitment to reduce Kosovo’s dependence on donor support for the budget. Grants will finance only one third of spending in 2001 compared with over a one-half in 2000.

Nevertheless, UNMIK must still do several important things to reduce risks to the budget. On the tax side, it is essential to broaden the tax base by implementing the VAT and introducing a wage tax. The VAT in particular is expected to make a significant contribution to tax revenue in 2001, but both taxes are vital for the funding of the budget in the long-term. Continuing efforts to strengthen tax administration and train local tax supervisors are also a priority. On the expenditure side, while the overall wage bill is not large by the standards of transition economies, the over employment in the health and education sectors should be scaled back. Also, stronger efforts should be made to reduce staffing in public utilities and improve bill collection in order to eliminate the high subsidy cost to the budget. More generally, UNMIK needs to resist pressures to raise budget wages—wage levels are not low when related to Kosovo’s development level—and continue to resist pressures to put industrial subsidies in the budget, a mistake made in other transition economies.

IMF staff have also looked beyond the current year budget in an attempt to gauge the sustainability of public spending levels and the longer-term implications for donor support. This is quite a speculative exercise in view of the political uncertainties as well as the many unknown economic factors. The conclusions, presented in more detail in the paper that is available to conference participants, can be summarized as follows:

• Even under relatively optimistic assumptions, Kosovo will continue to face tight budget constraints. In the short-term, rising tax revenues will largely be offset by declining donor support. Meanwhile, health and social expenditure demands will remain high and the budget will have to shoulder an increasing burden of capital maintenance and expanded public services.

• In the long-term, the budget will need to absorb some big ticket items such as investment and defense, which are currently provided for directly by donors. The budget could also face pressures from debt service and more elaborate social benefits such as pensions.

• Rapid economic growth is essential to ensure that the pressures on public spending and services will not be overly severe in the future.

For UNMIK and donors, the main messages that come out of this analysis are as follows:

• UNMIK needs to facilitate an enabling environment for private sector development and place priority on establishing a broader tax base. Also, long-term spending commitments should also not be made before financing sources are secure as this could unreasonably burden UNMIK’s successors.

• Donors might have to accept a more gradual phasing out of budget support if the straitjacket on public spending and the welfare system is not going to be too tight. This can be justified if UNMIK continues to make good progress in institution building and continues to budget in a realistic manner.