External economic relations of the Republic of Macedonia

External economic relations of the Republic of Macedonia «External economic relations of the Republic of Macedonia» by Mihail Petkovski Source: SEER South East Europe Review for Labour and Social Affairs (SEER South East Europe Review for Labour and Social Affairs), issue: 03 / 2001, pages: 113 123, on www.ceeol.com. The following ad supports maintaining our C.E.E.O.L. service

Mihail Petkovski External economic relations of the Republic of Macedonia Introduction External economic relations are of enormous importance for a small country like Macedonia for two basic reasons. Firstly, due to its small territory, Macedonia is not endowed with natural resources of various kinds and this makes it dependent on imports of many raw materials. Secondly, imports of capital, new technology, know-how, management skills and expertise, all of them associated with foreign investment, seem to be a critical ingredient in the process of the economic development of Macedonia. This paper is focused on foreign trade flows, which represent the most important part of Macedonian external economic relations. It discusses the main trends in Macedonian foreign trade, the level of trade integration of the Macedonian economy with the most important groups of countries, and the industrial structure of the country by sector and by product. It briefly sheds light on the dynamics of foreign direct investment, which is usually closely linked with foreign trade flows. Finally, it provides a short analysis of the economic impact of the military conflict which broke out in Macedonia in February this year. Main trends in Macedonian foreign trade Since 1991, Macedonian foreign trade has suffered a number of adverse external shocks: the break-up of the former Yugoslavia and the war that followed in some of the successor states after Yugoslavia s violent dissolution the collapse of the CMEA trade zone and the loss of traditional east European markets the UN Security Council sanctions imposed against rump Yugoslavia (now the Federal Republic of Yugoslavia-Serbia and Montenegro) in 1992, which Macedonia had to observe the unilateral Greek embargo against Macedonia, imposed in February 1994 and lifted at the end of 1995 after the New York agreement between Greece and Macedonia regarding some aspects of the well-publicised dispute, including the Macedonian name, flag and so forth the Kosovo crisis in 1999, when Macedonia accommodated some 300,000 refugees (about 15% of its population) and, temporarily, lost the very important Yugoslav market military conflict between government forces and ethnic Albanian extremists (strongly supported from Kosovo), which started in February 2001. Macedonia experienced the first four unfavourable external shocks during the first years of its independence. Therefore, it is not surprising that there was a steady decrease in total foreign trade during the 1990-1994 period. Imports were especially hard hit and, by means of their contraction, Macedonia, after a long period, was able to achieve a balance in its external accounts. For example, the trade deficit in 1992 was at its lowest level of just $7.5m, which was 98 per cent less than the 1990 level, when it amounted to $418m (see Table 1). 3/2001 South-East Europe Review S. 113 124 113

Mihail Petkovski Table 1 Foreign trade of the Republic of Macedonia, 1991-94 ($m) 1991* 1992 1993 1994 Total exports of goods 1,150.0 1,198.6 1,055.3 1,067.5 Regular exports 661.0 888.7 959.8 979.2 Others 489.0 309.9 95.5 88.3 Total imports of goods** 1,375.0 1,206.1 1,199.4 1,441.5 Regular imports 1,006.0 963.0 1,129.7 1,225.8 Others 369.0 243.1 69.7 215.7 Net exports -225.0-7.5-144.1-374.0 Regular -345.0-74.3-169.9-246.6 Others 120.0 66.8 25.8 127.4 Source: Ministry of Development, Republic of Macedonia. Notes: * Figures include $55m in exports and $101m in imports with Slovenia and Croatia after their independence; official data do not include these amounts. ** CIF basis. Exports did not fall that sharply in the first years of independence, but the overall results were unsatisfactory. The nominal value of exports in 1994 was $1.068bn, lower than the 1990 level of $1.128bn although this latter figure did not include trade with the Yugoslav republics, which implies a much bigger de facto decrease. Not until 1995 was a certain rehabilitation in exports witnessed, when Macedonia renewed its access to external finance, mainly through the international financial institutions. Macedonian exports were once more severely hit by the Kosovo crisis but, with the end of the hostilities, they did start to pick up again, although their total value in 1999 was significantly lower than in 1998 (see Table 2). The further acceleration of exports is expected to have occurred in 2000. 114 South-East Europe Review 3/2001

External economic relations of the Republic of Macedonia Table 2 Foreign trade of the Republic of Macedonia, 1995-2000 ($m) 1995 1996 1997 1998 1999 2000* I. Trade in goods Exports of goods 1,205 1,147 1,237 1,322 1,192 1,345 Imports of goods (FOB) 1,424 1,464 1,623 1,722 1,601 1,831 Net exports of goods (deficit) -219-317 -386-400 -409-486 II. Services** Exports of services 185 154 128 131 237 199 Imports of services 385 309 273 303 304 325 Net exports of services (deficit) -200-155 -145-172 -67-126 Source: National Bank of the Republic of Macedonia Notes: * Estimates. ** The item services includes foreign exchange inflows and outflows from: transportation; foreign tourism; construction work in foreign countries; forwarding services; insurance; banking services; consulting; and other services in transactions with other countries. Generally, it can be concluded that foreign trade performance has, so far, not been particularly satisfactory. During the period from 1992 to 1998, the cumulative increase in exports was 18%, which represents much slower growth than in the successful transition economies. Imports grew much more quickly about 59% in the same period (on an FOB basis). Evidently, despite Macedonia s relatively high level of trade openness, the imbalance in trading performance is due much more to the growth in imports than it is to exports. The share of exports of goods and services during the last few years has been in the range of 30% to 40% of GDP. For comparison, the more advanced transition economies which are of a similar size (Slovenia, Estonia, Latvia, etc.) record exports ranging from 50% to 70% GDP, or even more. However, both the IMF and the World Bank did anticipate, starting in 2000, an acceleration in Macedonian export growth, provided that structural reforms in the banking and the real sector continued. These expectations did indeed materialise for 2000, but exports will actually fall in 2001 as a result of the impact of the military conflict. Table 2 also shows that foreign trade in services represents a relatively small part of total trade. The ratio of exports of goods to exports of services was 91:9 in 1998, whereas the world average was 80:20 in the same year (WTO, 1998). The level of openness of the Macedonian economy During the previous decade, the Macedonian economy became much more open to international trade than it was in the 1980s. There are three explanations for this important development. Firstly, trade liberalisation, started by the last former Yugoslav government, has been more or less continued by each Macedonian government. Secondly, the break-up of former Yugoslavia automatically caused a significant increase in trade openness 3/2001 South-East Europe Review 115

Mihail Petkovski because the trade previously conducted between the Yugoslav republics became foreign trade. Thirdly, foreign trade growth was much faster than output growth, which was actually negative for the entire 1989-1999 period. As can be seen from Table 3, the Macedonian economy is the most open amongst all the south-east European economies, although it is, of course, less open than the advanced transition economies. Table 3 Trade indicators for central and eastern European countries, 1998 Exports and imports (per cent of GDP) Exports to the EU (per cent of total exports) Albania 42 83 Bulgaria 98 46 Croatia 95 55 Czech Republic 116 60 Estonia 170 70 Hungary 122 70 Latvia 110 55 Lithuania 107 46 Macedonia 103 43 Poland 55 67 Romania 59 58 Slovak Republic 119 49 Slovenia 115 68 Source: Weber and Taube (2000). Geographical distribution of foreign trade The experience of developed countries is that the geographical distribution of trade flows is primarily determined by so-called gravitational factors (Anderson, 1979): distance; cultural affinity; and the size of the market of the trading partner. However, Krugman (1991) suggests that historical accidents may also have a permanent impact on trade flows. Amongst the transition economies, there are examples of very different evolutions of foreign trade patterns. The Baltic states achieved an extremely rapid re-orientation of their trade from the former Soviet republics towards western markets, while the CIS countries represent a clear case in the opposite direction, being still to a very large extent dependent on trade links with the Russian market. 116 South-East Europe Review 3/2001

External economic relations of the Republic of Macedonia As can be seen from Tables 4 and 5, Macedonia is in an intermediate position. It has an industrial structure that suggests the possibility of very intensive trade with western Europe. On the other hand, geography and cultural factors favour strong integration with its regional partners. Outside of these two groups of countries, only the USA is an important trading partner. Table 5 reveals that the regional distribution of Macedonian exports is not strongly diversified. Macedonia sells over 80% of its exports to 14 countries. Only five or six of these, however, can be considered as strategic partners. By comparison, Slovenia, which already has 14 strategic partners, intends to enlarge this number to 20 in the attempt to increase the essential stability of its economy. Table 4 Regional distribution of foreign trade, 1999 (% of total) Country group Exports Imports Developed countries 60.2 50.7 European Union 44.7 40.1 EFTA 2.7 1.3 Other developed countries 12.8 9.2 Transition economies 6.3 21.0 Underdeveloped countries 0.3 0.1 Developing countries 2.8 5.3 Former Yugoslav republics 29.9 22.8 Others 0.5 0.0 Source: National statistics 3/2001 South-East Europe Review 117

Mihail Petkovski Table 5 Most important foreign trade partners of the Republic Macedonia in 1999 (% of total) Country Exports Imports Germany 21.4 13.7 FR Yugoslavia 21.3 10.1 USA 11.4 4.0 Italy 5.9 5.2 Greece 7.2 9.1 Slovenia 2.9 8.7 Bulgaria 2.2 5.1 Ukraine 0.3 6.4 Croatia 4.1 3.4 Russia 1.3 5.1 Netherlands 3.4 2.2 Switzerland 2.5 1.2 Austria 0.5 2.5 Turkey 0.5 2.5 Total 84.4 76.7 Source: National statistics Macedonian foreign trade by sectors and products Exports The structure of exports according to final use has basically remained unchanged in the period following independence. Macedonia mainly exports industrial supplies (intermediate goods) and consumer goods (food, beverages and tobacco). The share of investment goods is very small and is showing a tendency to decrease (see Table 6), which is not a positive sign for future economic developments. Table 6 Exports by final use, 1990-1999 (as % of total) Republic of Macedonia 1990 1992 1995 1997 1998 1999 Industrial supplies 59 43 54 52 49 48 Investment goods 5 3 4 3 4 3 Consumption goods 36 51 37 45 47 47 Other 0 3 5 0 0 2 Source: National statistics 118 South-East Europe Review 3/2001

External economic relations of the Republic of Macedonia The structure of industrial exports (which amount to around 80% of total goods exports) is characterised by the predominant participation of basic metals, textiles and leather. This structure is unfavourable, bearing in mind that the textile industry and black metals are two industrial sectors which have a very high share of non-regular exports in total produced output. Within agricultural exports, the most important groups of products are (according to the 1996-98 averages): tobacco and tobacco products 38%; foodstuffs 34% (of which fruits and vegetables 21%; and lamb and mutton 4%); beverages (wine, juices, etc.) 24% (Export Strategy for the Republic of Macedonia, p. 18). As can be seen, Macedonia has a narrow export base, with a relatively small number of important groups of export products. On the other hand, there is a high degree of dispersion of exports (over 1,500 products) which perhaps nevertheless reflects their rather residual and inefficient character (Petkovski, 1995). Imports The changing external environment and the trade reforms initiated by the former Yugoslavia in 1990, and continued by the Republic of Macedonia, have significantly altered the composition of imports in the recent decade. The largest, but decreasing, share consists of industrial supplies (i.e. raw materials, as well as energy and semifinished products) while that of capital goods has remained about the same. Particularly rapid has been the growth in the import of consumer goods, the demand for which was suppressed during the 1980s through various barriers and which has now been released as a result of trade liberalisation. For example, in 1999, industrial supplies accounted for 63% of total imports while consumer goods took 22.4% and investment goods 14.1% (see Table 4). This contrasts with import shares of over 80% for industrial supplies, 6-8% for consumer goods and 12% for capital goods in the late 1980s (World Bank, 1995: p.20). Table 7 Imports by final use: 1990-1999 (as % of total) 1990 1992 1995 1997 1998 1999 Industrial supplies 67 69 58 52 65 63 Investment goods 6 7 11 10 11 14 Consumption 25 24 31 28 21 22 goods Other 0 1 1 1 1 1 Source: National statistics The largest single categories of imports are petroleum and its derivatives, clothing, vehicles, iron and steel, meat and meat products, machines, and wheat and wheat products. It seems that there is a relatively high degree of inelasticity of import demand, so the only way to sustain the present volume of imports is to achieve relatively faster growth in exports. 3/2001 South-East Europe Review 119

Mihail Petkovski Foreign direct investment inflows FDI flows in the Balkan countries have remained relatively weak compared to other zones in the world economy, or to other east European countries such as Hungary and Poland. Even within this group of countries, Macedonia significantly lags behind the (relatively) more successful performers (Bulgaria, Croatia, Romania). These disappointing results could be primarily explained with reference to the high domestic and political risks, but also to the type of privatisation programme (insider-oriented) and the reform agenda that remains outstanding. With the acceleration of reforms in 2000, FDI started significantly to intensify but was again discouraged when military conflict broke out at the beginning of 2001. Subsequent to independence, 2000 was the year of the largest foreign investment in the banking system, resulting in significant changes in the shareholding structure of Macedonian banks. As at December 31 2000, the share of domestic banks in total assets was 45.5 per cent; at the end of 1999, it had been 87.2 per cent. At the same time, the share of domestic banks in the total capital of the banking system declined from 83.3 per cent at the end of 1999 to 50.1 per cent at the end of 2000. These major changes are primarily due to the privatisation of the largest Macedonian bank, Stopanska banka, in which the share of foreign capital amounts to 91.8 per cent of total capital. Generally speaking, it is obvious that capital attracted in the form of FDI in Macedonia is still relatively small. It has not sufficiently affected the most important spheres of the economy, from where it could induce more dynamic growth and the development of the economy as a whole. On the other hand, given that in 2000 the regime for foreign investors was significantly improved (through important changes in legal infrastructure and tax cuts), it can be concluded that there is a significant potential for foreign investment in the Macedonian economy which has yet to be drawn on. Table 8 FDI in south-eastern Europe ($m) Source: EBRD Cumulative FDI inflows 1989-2000, per capita 1998 1989 1999 2000 Albania 45 51 92 161 Bulgaria 537 806 975 407 Bosnia and Herzegovina 100 90 117 71 Croatia 801 1374 750 907 FR Yugoslavia 112 50 300 13 FYR Macedonia 175 27 169 219 Romania 2079 1070 1000 303 120 South-East Europe Review 3/2001

External economic relations of the Republic of Macedonia The most recent shock: the economic impact of the military conflict in 2001 Military clashes broke out between ethnic Albanian extremists and government forces near the border with Kosovo in mid-february 2001. The Albanian extremists had strong logistical, financial and military support from Kosovo and, as a result, the fighting spread to other predominantly ethnic Albanian areas in the north and northwest of the country. An internationally-mediated peace agreement was signed in August by the four main political parties in the Republic of Macedonia, representing ethnic Macedonians and ethnic Albanians. The agreement specifies the conditions under which Albanian extremists would end the military conflict. The conflict contributed to a significant deterioration in the general economic situation, which had been strong in the previous year. 2000 was the fifth consecutive year of growth for the economy in which, for the first time in the last two decades, GDP growth exceeded 5 per cent. Compared with 1998, the country doubled its foreign exchange reserves, exported 6 per cent more goods and collected 6 per cent of GDP more in revenues. The government also retained, for the first time, almost 3 per cent of GDP as a fiscal surplus. Having all this in mind, the growth prospects for 2001 looked favourable. The economic impact of the crisis, however, has completely changed this scenario. GDP for the first quarter of 2001 is estimated to have contracted by 5 per cent compared with the same period in 2000, while growth for the year as a whole is likely to be negative, in the range of 3-5% (compared with a pre-crisis projection of +6%). Industrial production is estimated to be about 10 per cent lower compared to the position in the previous year. Additional military spending, in combination with declining revenues (due to the depressed economic activity), will result in a high fiscal deficit. General government deficit for the year as a whole is likely to exceed 8 per cent of GDP, compared with a target in the IMF-supported programme of 1.2 per cent. Table 9 Main economic indicators, 2001 Pre-crisis scenario Latest estimate Gross domestic product (%) 6.0-4.5 Inflation rate (%) 5.8 6.6 General government budget -1.2-8.0 (% of GDP) Current account (% of GDP) -6.0-11.0 Source: National authorities External economic relations have also been seriously affected by the crisis. Trade with the Federal Republic of Yugoslavia, Macedonia s most important trading partner, fell by more than 20 per cent year-on-year in the first half, due to the closure of trade routes to the north and general uncertainty about developments in the country. Overall, exports are expected to fall for the year as a whole by 10 per cent, and non-military exports by even 3/2001 South-East Europe Review 121

Mihail Petkovski more. Private transfers and foreign investment fell sharply, reflecting the collapsing confidence in the domestic economy. The current account deficit is likely to be more than $150m further in deficit for the full year than had been projected prior to the conflict. The central bank lost about $167m in reserves during the first half of the year. The Macedonian Chamber of Commerce estimates that the economic costs of the crisis amount to $800m for the first seven months of the year. Given that Macedonia s creditworthiness is evidently lower than it was before the conflict then, without adequate help from the international donor community, it will be difficult for the Macedonian economy to return to the growth path it had reached in 2000. Up to now, the international community has been very slow to react even to the humanitarian aspects of the crisis, in stark contrast to its behaviour during the Kosovo crisis in 1999. Conclusion The Republic of Macedonia is a small, open economy with a prosperity tied closely to its achievements in foreign trade. Under extremely difficult external circumstances since independence, the value of Macedonian foreign trade in goods and services has described a constant, albeit relatively shallow, growth curve. Macedonia has the most open economy of all the south-east European countries. In the coming decade, the Macedonian economy will be increasingly integrated with the world economy and, thereby, exposed to world trends in globalisation and liberalisation. Given its aspirations towards EU integration, and the need to grow more rapidly than the richer countries, it will be forced to minimise the use of trade protection and to open up its economy radically. Exports should be a major driving force behind a sustainable acceleration in economic growth and, furthermore, for economic convergence with EU countries. The economic situation in Macedonia, however, depends very much on regional and domestic political developments. The military conflict which started this year has interrupted the process of fast and healthy growth recorded in 2000 (which could have been sustained if structural reforms were continued and prudent macroeconomic policies maintained). If peace efforts succeed, external finance will be crucial to the effective implementation of structural reforms, as well as to the implementation of policies and investments to develop the economy in the long run. Should there be a significant shortfall in external support, the country s acute financial stress would be aggravated and the recovery of the economy would be too slow, generating high economic and social costs. References Anderson, J. (1979): A Theoretical Foundation for the Gravity Equation, American Economic Review, March. EBRD (2001): Transition Report Update 2001, London. Export Strategy for the Republic of Macedonia, The Macedonian Academy of Arts and Sciences, 1999. Krugman, P. (1991): Increasing Returns and Economic Geography, Journal of Political Economy, 99. 122 South-East Europe Review 3/2001

External economic relations of the Republic of Macedonia Petkovski, M. (1995): Eksterniot sektor i makroekonomskata stabilizacija (The external sector and macroeconomic stabilisation), The Macedonian Academy of Arts and Sciences. Weber, R. and G. Taube (2000): Estonia Moves Towards EU Accession, Finance and Development, IMF, September. World Bank (1995): Former Yugoslav Republic of Macedonia: An Introductory Economic Report, Country Operations Division, Country Department: Europe and Central Asia. WTO (1998): World Trade Report 1998. 3/2001 South-East Europe Review 123