Public debt and feasibility of instruments in Western Balkans 6
For the purpose of reviewing the public debt conditions in the WB6 countries, the trends of debt in the ten-year period 2010–2020 was assessed. Given that the entire decade has been post-crisis, following the global financial crisis in 2008, it is to be expected that each of the countries will record an exponential trend of public debt growth. The new Covid-19crisis period begun in 2020, which is primarily characterized by a decline in GDP and an increase in public debt is expected due to the need to finance the health sector as well as economic support programs.
What is noticeable in methodological terms is that there is no consistency in public debt reporting methodology of the Western Balkan countries. Each country has its own approach to reporting. However, over a ten-year period, improvements in the quality and coverage of reports, as well as levels of transparency, are very evident. Table 2 provides an overview of the data on public debt, its ratio to gross domestic product (GDP), as well as the structure of the public debt portfolio of the WB6 countries.
Table 2 illustrates that the condition of WB6's public debt at the end of 2020ranges widely, from 24% in Kosovo to 102% in Montenegro. The trend of the debt movement was continuously progressive, except in Serbia and Bosnia, which in the second part of the period, after 2015, managed to reduce the share of public debt in GDP. Other countries have managed to double, and some have tripled, their public debt in the past decade.
Five countries, except North Macedonia have fiscal rules in place. All of them have a rule limiting debt, but there are differences in a size and nature of the limit. Size of the limit differs form 40% in Kosovo, 45% in Albania and Serbia and 60% in Montenegro and Bosnia and Herzegovina (Kikoni et al., 2019). It is clear that all countries, except Bosnia and Herzegovina and Kosovo, have been violating this fiscal rule for some time. The COVID crisis is likely to further slow these countries' ability to comply with the public debt limit. The public debt of the WB6 countries is predominantly external, except in Kosovo, where, starting in 2015, the situation is changing in favor of domestic debt. Also, public debt is dominant and euroized in countries that have their own currency.
As for the public debt portfolio, each of the countries has certain specificities, depending on the economic and political heritage. Those who had liabilities based on old foreign currency savings, restitution and unpaid pensions have securitized them and are present in the portfolio of their domestic debt. Each of the countries in its portfolio has loans from multilateral and bilateral creditors, government securities, euro-bonds and private sector creditors loans.
At the beginning of the decade, multilateral and bilateral creditors loans were most dominant in the public debt portfolio, and over time their share decreased with the exception of Bosnia and Herzegovina, where these loans continuously participate with about 70% in the total portfolio. The decrease in the share of these loans in most countries was in favor of the increase in the share of government securities, this time with the exception of Montenegro, which has changed the structure of its portfolio in such a way that euro-bonds and private sector loans have become the most important means of financing public debt.
Government securities involve the issuance of bonds and treasury bills. The fact that North Macedonia, Serbia, Kosovo and Albania have 30–60% of these securities in their portfolio speaks not only of domestic confidence, but also of the capacities of domestic banks and institutional investors.
The fact that all countries except Kosovo and Bosnia and Herzegovina, and some even before 2010 had successful euro-bond issues, also indicates the presence of confidence of international investors.
When it comes to the debt maturity, countries do not usually publish a single average maturity figure. Data which are mainly given refer to the maturity structure, which show that long-termsecurities are predominantly present in the portfolio. Specifically, Montenegro published data that the average maturity at the end of 2020 was 6.9 years, while the same data for Bosnia and Herzegovina for 2019 was 7.7 years. Also, the ratio of debt to fixed and variable rates in most countries is in favor of fixed or is balanced.
All of the above leads to the conclusion that Western Balkans 6 will have a specific challenge to manage their public debt in this so-called traditional way. It will be particularly interesting how and to what extent the governments of these countries will know how to recognize and be able to introduce new borrowing instruments.
One of the modalities recently proposed by the IMF researcher (Willems, 2021) based on the Klemperer’sProduct-Mix Auction approach. It is proposed to hold auctions overcome issues related to the classic sovereign debt restructuring negotiations. The application of an auction model offers a platform that enables participants to engage based on their preferences rather than one-size-fits-all approach, which causes enormous difficulties. Such preferences may relate to bonds different in maturity or denominated in different currencies.
Table 2. Public debt portfolio of the Western Balkan 6 countries
|
Montenegro
|
North Macedonia
|
Serbia
|
B&H
|
Kosovo
|
Albania
|
|
2010
|
2015
|
2020
|
2010
|
2015
|
2020
|
2010
|
2015
|
2020
|
2010
|
2015
|
2020
|
2010
|
2015
|
2020
|
2010
|
2015
|
2020
|
GDP (mil EUR)
|
2104
|
3625
|
4245
|
7109
|
9072
|
10766
|
31546
|
35740
|
47156
|
12969
|
14618
|
17322
|
4402
|
5807
|
6831
|
8933
|
10448
|
12710
|
Public debt % GDP
|
42
|
61.6
|
102.4
|
24.6
|
38
|
60.2
|
42.9
|
76
|
56.8
|
33.8
|
40
|
35
|
6.2
|
13.0
|
24.6
|
57.7
|
72.8
|
77.9
|
Public debt portfolio (% of total public debt)
|
Multilateral and bilateral creditor loans
|
46.4
|
27.7
|
13.7
|
49.2
|
25
|
n.a.
|
46.6
|
35
|
37.8
|
66.6
|
70.4
|
68.5
|
n.a.
|
49.25
|
33
|
18.9
|
25.7
|
25.6
|
Eurobond
|
15.7
|
39.6
|
44.9
|
19
|
22.3
|
n.a
|
0
|
19
|
19
|
0
|
0
|
5.4
|
n.a.
|
0
|
0
|
3.36
|
4.31
|
9.05
|
Private sector loans
|
9.8
|
18.1
|
32.5
|
|
13.6
|
n.a.
|
0
|
5
|
0.9
|
0
|
4.13
|
1.85
|
n.a
|
0.45
|
1.4
|
3.03
|
6.38
|
3.07
|
Government securities
|
3.9
|
4.37
|
4.2
|
31.3
|
38.9
|
n.a.
|
47.5
|
30.5
|
39.5
|
11
|
10.4
|
15.8
|
n.a.
|
50.5
|
64.7
|
32.41
|
36.32
|
40.12
|
Source: Statistical Offices and Ministry of Finance websites of WB6 (Montenegro: www.mif.gov.me (Ministry of Finance), www.monstat.org (Statistical Office) Serbia: www.javnidug.gov.rs (Public Debt Administration), North Macedonia: www.finance.gov.mk (Ministry of Finance), www.stat.gov.mk (Statistical Office), Albania: www.financia.gov.al (Ministry of Finance), www.instat.goval (Statistical Office), Bosnia and Herzegovina: www.mft.gov.ba (Ministry of Finance), www.bhas.gov.me (Statistical Office), Kosovo: www.mf.rks-gov.me (Ministry of Finance) www.ask.rks-gov.net (Statistical Office))
The swap scheme’s new lease of life?
Given the analysis of the fiscal positions of the countries of the WB6 it is clear that further macro fiscal deterioration may be expected as countries face the impact of the Covid-19 crises. In the context of the of the EU accession process and the recently revealed European Green Deal, newly shaped market mechanisms for the UN2030 Agenda financing in the form of the green, social or sustainability bonds it is worth considering whether a further innovation is possible. This innovation may arise from already existing debt-for-nature swap which can trace its way back to the post WWII debt restructuring and later debt-for-equity instruments as explained in literature review. As explained one of the countries that has used this opportunity was Montenegro in 2009.
On the other hand it is evident that the EU is a willing partner and provides different mechanism of support. We will mention here the most important one, so-called Instrument of Pre-accession Assistance which begins its third 2021–2027 iteration. IPA serves to provide financial assistance to the candidate countries in order to meet political and economic criteria for the membership and is based on the strategic documents which point out necessary reforms in the fields of the rule of law, fundamental rights and governance; socio-economic development; Union policies and acquis; people-to-people contacts and reconciliation, good neighbor relations and regional cooperation. Expanding the previous IPA II mechanism to the areas of migration, security, protection of the environment and climate change should be the new feature. In fact, the debate in the Parliament during the first reading produced amendments which assuming Paris Agreement obligations aim at stronger connection between UN 2030 Agenda and IPA claiming the need to allocate 16% of the Program to the climate impact need in the beneficiaries. It also calls for the special attention to the cross-border polluting issues. Equally Parliament call for the European Fund for Sustainable Development plus to complement the efforts under the pre-accession programme (European Parliament, 2019; The European Parliament, 2019).As for the IPA III assistance purpose approximately EUR 14.5 billion has been proposed it would mean tagging more that EUR 2 billion for the climate related investments. Such allocation if finally approved in such form, could be an excellent leverage to generate lot more funding from the capital markets.
The debt analysis of the WB6 countries despite somewhat different situations clearly point out that there are many macro-fiscal challenges ahead and an innovative approach is needed. At the same time despite having relatively reduced fiscal space for additional borrowing while many structural requirements lie ahead it is obvious that individual countries GDP in purchase power is still significantly lagging behind the EU average, as Table 3 illustrates.
Table 3. WB6 GDP per capita in PPS
|
% of EU average in 2019
|
EU 27 average
|
100
|
Montenegro
|
50
|
Serbia
|
41
|
North Macedonia
|
38
|
Bosnia and Herzegovina
|
32
|
Albania
|
31
|
Source: Eurostat https://ec.europa.eu/eurostat/web/products-datasets/
With average score of 38[1] in 2019 year before the pandemic begun it is obvious how far countries need to go, and why any innovative mechanism is more than needed. It is only that sustainable development and a continuous positive trajectory can keep this part of the world secure and migration at bay.
Bringing together IPA and private markets, while combining the swap model and the new forms of issuing bonds which is more transparent and requires vigilante reporting and later verification, EU may further support countries of the Western Balkans by repaying part of the principal debt upon the independent verification of how proceeds are used and whether targets have been met. This can particularly be directly linked with the complementary Green Agenda for Western Balkans (European Commission, 2020) establishing number of initiatives in the different areas such as climate change, clean energy transmission, smart and sustainable mobility, circular economy, depopulation, sustainable food systems and rural areas and the protection of the biodiversity. In parallel to that Western Balkans countries should continue their accession process which means conducting series of different policies in order to join EU one day. Table 4 presents the KPIs that are used to help measure the EU’s contribution to the achievements of the candidate countries:
It is noticeable that there is no mention of the Human Development Index produced by the UNDP, which would also be of use when tracking the progress in the social sphere related to the education and health in particular.
Could green, social and sustainability bonds be a good fit?
Going back to the green, social and sustainability or ESG bonds in some form, they have key performance indicators and sustainable targets. Given that the European Commission uses different key performance indicators to monitor the progress the countries make those indicators could play important role. At the same time, the Green Agenda for Western Balkans sets off number of initiatives that could be transferred into the targets, both indicators and these targets can serve as an excellent basis for transparency and reporting required by the markets.
The availability of IPA III funds completes the picture as those resources can be used for the adjusted swap mechanism and used to pay for the fraction of issued green, social, sustainability bonds. Paying for that in the maturity year sets free additional resources in the troubled state budgets. Another option could be to issue higher amount of bonds while the markets realize that providing the implementation of the policies and meeting targets means that EU would use some of the funds to repay part of the bonds once they mature. Such mechanisms would bring another relief in the lower interest that would be paid each year, which provides additional financial means to implement the EU acquis. Altogether, countries could benefit from spurring economic growth based on sustainable and smart development while keeping public debt checked.
What exact targets and what exact portion of the bonds would be repaid by the IPA III allocation would depend on the type of a bond given different levels of support EU provides to the different areas of investments.
Some of the initiatives may easily be turned into clear targets some would need further work to figure out the most proper indicators. For example, as far the initiative related to the Biodiversity Action plan is concerned, first target might be the adoption of a proper action plan followed by some key action points to be carried out.
The work of the SDG indicators as well as the efforts and the contribution of the UN Global Compact may help tremendously to that cause. This may also be the field of the further research.
Summary of recommendations
Figure 5 presents our summary of recommendations for the establishment of new financial instruments in the Western Balkans.
Obviously there are plenty of different possibilities to use some of the innovative models. The one which has been summarized below, takes off from the current macroeconomic situation in the Western Balkans explained above, which suggests many a structural issue to be tackled by the national governments.
All the WB6 countries stream to become member states of the EU. However, that road demands introduction of the very specific legislation which normally brings about the need to accommodate and adjust institutions requiring additional costs and more efficient and effective public administration in the end. Additionally infrastructure and overall development needs remain very high and macro-fiscal room has shrunk given the levels of the public debt in particular.
Therefore the innovative approach presented below offers a new modality of ESG bonds which are based on the EU process combined with the Green Agenda initiatives for the Western Balkans. This new bond mechanism would use some of the lessons and practicalities learned from the nature for debt swaps where green investments could lead to some debt relief. Countries should be encouraged to define clear targets based on the sustainable development policies and then go to the market with the transparent support of the EU through the IPA funds. The logic of the IPA funds is to prepare countries for the membership and are used to help meet various benchmark. Even the modality by which countries benefit from the direct budget support is conditioned by some prior action.
This new approach would bring about the synergy between private and public funds, would introduce very transparent targets and indicators verifiable by the independent auditors and would use the IPA funds as a powerful leverage that can help save some interest or principal repayment cost and thus help a country lower their public debt and reinforce their international financial credibility or use the extra money for additional investments into the quality of the public administration or social infrastructure. Instead of chopping IPA between different sectors it would be more transparent and effective to use the contribution as an additional verification of the proper policies in place (it may combine rule of law with public administration reforms or sustainable development). Such an approach would increase accountability of the policymakers as well.
It would be crucial to develop more measurable targets as far as the Green Agenda for the Western Balkans initiatives are concerned. Other indicators which are reported by the international organizations (World Bank’s Doing Business for example are more straightforward). Evidently in some cases it takes new legislation to be produced, in other to implement. Any initiative which is measurable through additional regional mechanisms of cooperation is a value added as it contributes to the stability and prosperity of the whole area.