Macedonia - Quo Vadis?
An Executive Summary of a Research Report
Dated 10/1/2001

Issued by: Capital Markets Institute Ltd.
(Author: Dr. Sam Vaknin)

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Macedonia is geographically positioned to become a trilateral bridge between Asia, Western Europe and Eastern Europe. It is the heart of the Balkans. With the proper promotion and dissemination of information, it could well become an important regional economic hub, as well. To achieve this, it has to adopt an export orientation, to encourage the formation of small businesses, to be friendly to FDI (foreign direct investment), to deregulate and open up to (domestic and foreign) competition in its infrastructure (electricity, internet, telecoms, the banking system, etc.), to emphasize the protection of property rights and to start the process of privatization all over again - this time sincerely.

The World Economy in 2001

The Asian crisis is not over – it hasn't even started. It will erupt again, this time much more severely and mainly in Indonesia, Philippines, China, Malaysia and Japan. This will augment the recession shock waves in the USA. The stock exchanges (headed by Wall Street) will be the first to adversely react. The IMF will be fast depleted of resources. The central banks around the world will not be able to implement tighter monetary policies and global inflation will be re-ignited (with the exception of deflation in Asia). This inflation will be exacerbated by currency devaluations in South East Asia (China) and in Russia. The introduction of the Euro has further limit the flexibility of the counter-cyclical reactions of the economic authorities. This overall rigid response will force countries to adopt protectionist measures against the free flow of goods, services and, above all, capital.

The evaluation of the Macedonian economy in this paper, however, ignores this scenario. Should it transpire as we predict – the impact on Macedonia might be moderate, as its main markets are in the EU and it is not dependent on foreign direct investment but on multilateral aid and credits.

What We Predicted in 2000

(See article in "Makedonsko Delo" dated April 7, 2000)

At the beginning of the year 2000 we predicted the following:

The Euro will devalue to 0.87 versus the US dollar and then recover to 1.18.

In reality it went down to 0.83 and is now in the process of recovering.

We now predict a cap on Euro appreciation at 1.06 - 1.08 (equivalent to DM at 1.78). The US dollar will then recover and push towards 2.30 and beyond.

We predicted oil hitting 32 US dollars per barrel (Brent crude) and then swiftly declining to 18 US dollars and then (in the long term) back to 7-10 Us dollars. In reality, it reached 35-36 US dollars per barrel and commenced a precipitous decline (to 24 Us dollars currently).

We predicted a collapse of Wall Street. NASDAQ (the biggest stock exchange in the USA) has indeed crashed by 60% from its highs in March 2000 - but Wall Street, as a whole, did not experience a market meltdown as we predicted (though it is down by 15% from its highs).

The denar must be devalued gradually and transparently

The trade deficit (at 600 million USD) equals 16% of the (admittedly, only the official) GDP and the current account deficit amounts to almost 8% of GDP. This is AFTER unilateral transfers of capital from donor countries and aid agencies and from immigrants and after foreign investment. The reserves of the Central Bank cover 3 months of regular imports and, luckily, are insufficient to excite the big time speculators. Still, the currency is overvalued. In PPP-adjusted terms it should be converted at 37 to the DM (versus 31 now) and at c.70 to the USD (versus 66 now). The exchange rate stability is artificial, discourages exports and encourages imports. It also exerts deflationary forces in a deflation prone economy. The terms of trade of Macedonia have deteriorated by 14% these last few years. The accumulation of foreign exchange reserves is anti-growth and unnecessary. It also runs counter to current economic thinking.


The Macedonian economy is totally illiquid and demonetized. High unemployment, a low money supply and the only slightly improved presence of money multipliers or accelerators (such as functioning credit providing institutions coupled with reasonable credit ceilings and interest rates as imposed by the Central Bank) – have depressed any nascent inflation and, lately, led to demand core deflation (without volatile energy and food prices). To encourage growth, Macedonia must tolerate a 10-15% annual level of inflation (versus c. 5% now) and a minimum of 3-5% budget deficit (versus a surplus now, if we ignore the rebalancing of the budget). There is no need to fear hyperinflation because of low demand. A devaluation will be mostly absorbed by importers and manufacturers. The government’s fiscal and monetary policies are unduly restrictive and contractionary when they should be expansive. For a country in transition, with c. 40% unemployment, an 8% current account deficit, inter-company debt arrears of c. 30% of GDP and growing, low FDI and languishing private sector - to maintain a 35% tax burden and a structural budget surplus is, to put it mildly, very wrong.

If, however, the Central Bank will be forced by the market to devalue the denar – the result will be profits for speculators and an inflation out of control. This will lead to stagflation – runaway inflation coupled with economic stagnation (the worst possible scenario for Macedonia). However this scenario is unlikely as long as the IMF is seen to be supporting current structural reforms and monetary policies.

The Macedonian Central Bank is forced by the IFIs (especially by the IMF) to maintain a DUAL TRACK policy, namely to observe BOTH an inflation target AND a stable exchange rate. This is a classic mistake, badly regretted in many countries now (examples: Brazil, Russia, Argentina, Turkey and Israel). By law, the Central Bank should ascertain the stability of the denar exchange rate. It is advisable to alter the law so that the bank observes an INFLATION TARGET, with a floor and a ceiling (an inflation band).

The Banking System

The sale of "Stopanska Banka" to "National Bank" (from Greece) - as well as the sale of a few other minor players to foreign investors cum management - has finally opened up the banking sector to outside influences. Still, most foreign owners are either hesitant (Erste Bank, which withdrew from the bid for Stopanska Banka in 1999) or too institutional (EBRD, IFC and even "National Bank" itself) or marginal. The whole sector needs to be opened up to competition by allowing the introduction of credit unions, non-bank lenders, specialized (such as mortgage) banks, leasing companies, insurance companies, etc. into the banking scene.

The banks are ossified, unable to cope with the newly emerging market economy. They react either by disregarding the quality of their portfolio while over-emphasizing mere size (Stopanska Banka) – or by being too conservative. Instead of developing effective methods to monitor and evaluate risks – they preferred to raise the commercial interest rates to outlandish levels (now being reduced drastically). They offer no new services or products, lend only against real estate, favour cronies and cater to political wishes. The management in many of the banks in less professional than in the West. It is very likely that corruption is rampant due to favouritism and lack of transparency.

Only foreign ownership and CONTROL will alter this sorry state of things. In this respect, Macedonia is on the right path.

The Trade Deficit

The Macedonian economy is a “scavenger economy”. At first, it benefited from the siege imposed on Serbia by the international community. Greek and other goods were shipped through Macedonia to Serbia. A lot of people got rich in the process. Now, Macedonia lives off its reputation as a “stable” country. The USA and other countries finance its trade deficit and other financial excesses – just to keep it as a buffer and a protection against instability in the region. More than 50% of all Macedonian firms are trading firms. This cannot last and is no substitute to long term policies. Macedonia must move from scavenging to being a “predator economy”: eager to conquer new markets and prey on the competition.

A trade deficit is not inherently evil. If the money is spent on the importation of industrial raw materials and capital goods, the future profits will easily offset current deficits. But the Macedonian trade deficit goes to finance consumption goods and food. This is a malignant type of deficit, which will ultimately boomerang and hurt the local economy gravely.

What is needed is an orderly devaluation, the imposition of VAT on ever larger sectors of the informal economy and the imposition of some temporary import restrictions on luxury goods as well as the active encouragement of exports and, to a very limited extent, import substitution.

The Private Sector

The Macedonian people are very entrepreneurial. The level of corporate taxation is tolerable (though the total tax burden is NOT). But there is no private sector to talk about. This is because there is no management culture, a lot of bureaucratic red tape, no capital markets, no business-oriented banking system, no real incentives or environment available to exporters and to small businesses and a crowding out of credit by failing, politically connected, or state owned businesses. The privatization process transferred state assets to the hands of an elite of managers at a discount on real values. The workers also received shares but could not dispose of them in any meaningful way. Even companies which could easily have been sold to foreign investors were privatized in this manner : Alkaloid, Pivara, Ohis, to mention but a few (Makpetrol, the PTT, Elektrostopanstvo can also be included in the lists of “easily sellable companies”). The companies thus privatized still rely too heavily on the state and engage in political lobbying rather than in production.

Macedonia has this year, for the first time, embarked on a path of serious and painful structural reform (mainly by shutting down or selling the loss making state owned enterprises). This is commendable, courageous and important. But this is only half the job - and NOT the important half. The important part is to create the conditions to encourage the formation of a vigorous and viable private sector.

The Public Sector

Despite rumours to the contrary, the public sector is less corrupt than in comparable countries (according to Transparency International and to my own experience), well educated and capable. However, it is far too large (it should be cut in half) and inefficient. This sector is subjected to economic laws, which were either copied from the West verbatim or phrased locally by legislators and “experts” who lack the necessary experience. It is not service oriented, poorly paid and considered a “dead end” career.

Regional Devolution

The ethnic mix of Macedonia is explosive. This may be the reason why the central government was loath to transfer powers, authority and the money to back them to the regions. The regional economy is still very much centralized, planning is done from afar, the regions have no real taxing or spending autonomies (for instance : they cannot lobby abroad freely or raise funds in the capital markets because the land is not theirs to pledge, it belongs to the state).

But Macedonia is uniquely varied. It has an outstanding potential for tourism, transport and telecommunications. All of these can be developed regionally – rather than centrally. It is only the political will that is missing. In the world today – the central government is consciously transferring budgets and powers to the regions and the EU’s motto is : “A Europe of regions”. Macedonia has haltingly started to implement it – but the process is not fast enough.

Brain Drain

About 4% of the population left the country in the three years immediately following independence (1991-4). Another 2-3% left the country between 1994-8 (estimate). Many young people resent the fact the it is not merit that will determines their career path, but connections to the right people. Others face difficult personal choices : unable to buy apartments, they cannot form or raise families properly. Unemployment is a permanent feature and many young and unskilled or semi-skilled people are unemployed for years or reduced to menial jobs. This is a real threat to Macedonia’s economic future and competitiveness in the global market. In a way, Macedonia is subsidizing the West with this export of gifted people. Unfortunately, there is not a lot that can be done to directly counter this phenomenon. It will disappear of itself (even be reversed, as happened in Israel) once the economy improves.


This is the cancer of the Macedonian economy : psychologically as much as financially, a burden on the state, a burden on the unemployed. Hitherto there was no serious treatment of this problem. In 1998, the government introduced a structure of tax incentives intended to subsidize new employment. Due to abuses, it was cancelled by the new government. But even that was absolutely insufficient and, in isolation, inefficient. The unemployment rate (already at c. 40% according to official figures) – is poised to GROW as the economy becomes more efficient, technology is introduced and real privatization takes root. This will be a social calamity. Experience in the world can guide the government : to increase labour mobility, to decrease the power of unions, to transfer unemployment benefits to the employer (in order to encourage him to employ the unemployed), to initiate public works (a Macedonian “New Deal” even at the cost of budget deficits), to encourage small businesses (microcredits, incubators, tax credits, preference in government procurement), to organize barter communities with voucher money, to encourage part time and flexible forms of employment. Israel, Holland, Britain and the USA are good examples.

Higher Education

The Macedonian workforce is more educated than its equivalents in Southeast Asia, for instance. The quality of higher education is impressive, with a few notable exceptions. Despite some corruption (university diplomas that are bought in cash rather than earned through toil, as the rumours go) – the overall picture is encouraging. But the stock of education capital (buildings, laboratories, libraries, computers) has dwindled to the extent that Macedonian higher education is risking becoming obsolete and irrelevant. Moreover, the universities and dedicated schools are churning out graduates with degrees in professions, which are irrelevant to the Macedonian economy. There is a huge mismatch between what Macedonia needs and what Macedonia gets from its higher education institutions. In this sense, these institutions abdicated their social responsibilities. They are no longer subject to planning of any sort : central or via the market forces (because there is no market in Macedonia as of yet). The introduction of accredited private higher education institutions is a welcome step. It may ameliorate feelings of discrimination of minorities and elevate the quality of higher education in general by competing with staid and stultifying state establishments.

The Judicial System and Property Rights

The courts are slow, hesitant and ineffective. Contradicting interpretations of economic laws by different judges are not a rarity. The system is under-funded, understaffed and bogged in a landscape of laws and regulations, which changes arbitrarily. The introduction of autonomous budgeting is a step in the right direction. There are no private or public alternatives to the clogged, backlogged nightmare. The laws are full of irrelevant “dead weed”, are too complex and archaic or too open to interpretation. There are no reliable, publicly available central registrars of property and it, therefore, cannot fulfil the role of a collateral to the fullest extent. Intellectual property rights are not protected and Macedonia (with Bulgaria) is the piracy capital of Central Europe. All this – and the multi-annual tedious process of applying to the courts in the first place – erode the trust in the law enforcement system, in general and can bring about criminal alternatives to enforcement of contracts, for instance. There is no sign of a major reform in this field.

Taxation and the Black Economy

The “Black Economy” is called in Macedonia “The Grey Economy” because it is tolerated with a smile. Maybe luckily so : it comprises over 50% of the economy and is the less moribund and more vital part in it. Despite the fact that the taxes in Macedonia are very reasonable – collection is abysmal. Workers go unreported, income tax is paid only by employees in state or big firms, profit tax is eliminated by creative (false) accounting. Accountants in Macedonia are people who falsify books of firms so as to minimize the tax payable by them. Reform of the payment system and the customs is being discussed for months on end but, for some reason, its implementation is always postponed. Smuggling is rampant. This situation cannot be cured by “strong arm” tactics because it amounts to a universal civil rebellion. A massive education campaign needs to be launched to demonstrate to the citizens the benefits that they stand to gain from paying their due taxes. Because the distrust between citizen and government (no matter of which party, government in general) runs so deep – it will not be an easy or short term task. Corruption in high places - an all pervasive phenomenon - won't help either.

Some Recommendations

Government Structure and Budget

1. The development modern budgeting tools such as on-budget analyses, employment adjusted budgets, etc.

2. Independent budgeting for each Ministry and a system of incentives to those in the service of the government who save the moneyof the taxpayers. The Ministry of Finance should place budget-compliance supervisors in all the ministries (perhaps with the power to counter-sign budgetary expenditures together with the responsible Minister).

3. All public procurement is already subject to public, competitive, bidding in domestic and international tenders but reports about each should be submitted to a special Procurement Committee in the Ministry, headed by the Minister of Finance.

4. All NEW expenditures in the budget and ADDED budgetary items should be covered by corresponding items of income by LAW. All legislative initiatives concerning EXPENDITURES should, first, have to clear this hurdle: where will the money come from? This is theoretically so - but not in practice.

5. A clear division should be instituted in the budget between Development items - and current items. Borrowing should be encouraged and dedicated to the former - and abolished from the latter.

6. The government should introduce an amendment to the constitution regarding a budget deficit cap AND a budget surplus cap (limit) over the business cycle and, thus, ensure that future governments will not stray from the path of responsibility and fiscal rectitude.

7. I suggest to establish a National Budget Planning Office, which should provide the government with five year forecasts based on demographic, economic, geopolitical and technological trends.

Economic Legislation and Property Rights

1. I suggest to embark on a project of harmonization of all the economic legislation in Macedonia within a coherent and compact code, phrased in a manner which should be understandable to all, free of contradictions and unsuitable articles and provisions.
To do this, the government can create a special Council, which should be composed of legal experts, business and financial consultants,representatives of the private sectors and the relevant Ministries. All laws should be reviewed and, where necessary, re-written, to protect property rights  including protection of intellectual property rights : copyrights, brandnames, registered trademarks.

Data and Statistics

1. The government should develop interlinked national databases, which should serve the executive branch in its fight against crime, tax evasion and corruption. All the organs of the state should be bound by law to transfer all the data that they accumulate to these national, computerized databases.

Public Access

1. The Ministry of Finance should establish the following public access and right to know (freedom of information) institutions:

(a) Institutions of appeal on all levels and subject itself, willingly, to criticism and legal challenges.

(b) It should encourage feedback from the people and promises to study each suggestion carefully and to respond on it in a
reasoned manner.

(c) An office of Ombudsman (for citizen complaints) should be established. The ombudsman should have real powers and should answer directly to the Minister.

(d) Citizens and businesses should be able to obtain pre-rulings and opinions regarding tax matters from the tax authorities. The pre-rulings should be binding upon the Ministry and the tax authorities. They should introduce an element of certainty into the economic sphere.

(e) Citizens and businesses should have full access to their files.

Taxation - Direct and Indirect

1. The Ministry of Finance should establish national databases to track property purchases and compare them to declared income.

2. On the other hand, this government should rationalize the tax system by extremely simplifying it, by eliminating numerous loopholes, exemptions and deductions, by increasing the personal allowances, by drastically reducing the tax rates and by introducing other consumption and excise taxes. SIMPLIFICATION AND STREAMLINING of the TAX CODE are a major challenge.

3. It should be evident to the citizen that the money that he paid to the tax authorities was used to his immediate benefit. This is why this government should embark upon a massive campaign in the media and by direct mail, to explain to the citizens the benefits of paying taxes with DIRECT and IMMEDIATE examples. This is why this government should earmark 50% of all VAT revenues to educational, sports, academic and other public benefit or infrastructure projects.

Inflation, Interest Rates, Exchange Rates and the Central Bank

1. The Central Bank of Macedonia should switch to inflation targeting rather than foreign exchange management.

2. The bank should be allowed to determine the targets for the money supply, interest rates, inflation and other monetary parameters.

3. We should liberalize the trading of foreign exchange, abolish all manner of exchange controls and allow the market to fix the exchange rates. The Central Bank should be confined to managing the daily inter-bank trading and settlement in foreign exchange and it should publish a non-binding "middle exchange rate" for the day. Otherwise, it should have no involvement in this market.

4. The Supervision of the Banks should be removed from the Central Bank and become an independent unit, nominally under the Minister of Finance.

5. The Central Bank should have its own budget. It should be barred by law from transferring any of its profits to the national budget. Its autonomy should rest on its financial self-sufficiency.

6. An amendment to the National Bank Act concerning the investment of the country's foreign exchange reserves should be introduced.

The issues to be tackled in this amendment should be:

(1) WHAT constitutes foreign exchange reserves (is the stabilization fund included? Other state deposits? foreign credits? etc.)

(2) IN WHAT can these reserves be invested (TYPES of investments: bonds, equities, CDs, repos, etc.)

(3) The QUALITY and MATURITY of said investments (only investment grade bonds, gold 99.9% bullion, etc.)

(4) The PROPORTION of investments in each type of investment vehicles (e.g. 80% in T-bills, 10% in gold, etc.)

(5) WHO can and is authorized to decide about the investment of the foreign exchange reserves

(6) The decision making PROCEDURES, forms, quora, fora, etc.

(7) USES of foreign exchange reserves


(9) REPORTING procedures, periods, format, extent of disclosure

Banking, Finance and the Capital Markets

1. The government should reduce the capital requirements to open a bank, to allow for increased competition in this sector. It should, however, screen applications more carefully and refuse investors with no thorough background in banking or with a suspicious background.

2. The government should encourage non-banking financial institutions and encourage banks to open branches throughout the country by reducing the capital required to do so.

3. The function of Bank Supervision should be separated from the Central Bank and transferred to a distinct government agency with judicial and criminal prosecution powers. However, liquidity and reserves policies should still be determined by the Central Bank.

4. All the banks should be required to manage their accounts using western accounting methods and to be audited by a Western auditor.

5. The banks should supply the Supervision authorities with quarterly exposure and asset risk assessments.

6. To reinstate the trust between the population and the banking system, the government should strengthen considerably the role and the financing of the Deposit Insurance Agency. The government fully guarantees its obligations by law - but should make the necessary funding allocation to back up this promise.

7. By providing tax incentives, the government should encourage the banks to computerize and to reduce their costs (and the waste of their clients' resources) by performing more and more banking functions through unmanned teller machines, ATMs, internet banking and so on.

8. The banks should NOT administer the government's plans for small businesses and for export encouragement.

9. This government should regard the Stock Exchange as a prime financing instrument in the economy. It should encourage its activities in many ways. It should offer tax breaks (up to total exemption from capital gains tax) to owners of stock in listed companies, it should educate the public as to how to use the Stock Exchange as a capital market - and as to how to trade in it, it should encourage employees and managers who received stock during the privatization process to trade their shares through the the Stock Exchange by introducing local and foreign investment funds and investment pools as well as investment managers, it should establish free legal and accounting services for firms who wish to be listed, it should continue the process of privatization through the Stock Exchange, it should raise and recycle some of its internal debt through the Stock Exchange and establish (with the Central Bank) Open Market Operations, it should not tax long term holding of shares, it should support the creation of mutual funds and voucher funds.

Foreign Direct Investment (FDI) and Free Trade Zones (FTZ)

Foreign investment can be attracted by:

1. Appealing to Macedonians abroad, offering them special treatment. Their funds should be invested in a "Macedonia Fund", managed by a FOREIGN trustee.

2. Participating in a Venture Capital Fund for Macedonia

3. Encouraging prime Macedonian firms to list and trade their securities abroad (in the form of Depository Receipts)

4. Establishing a court dedicated only to Foreign Investors and obliged to render its judgements speedily (the law will define an obligatory period).

The Informal Economy

Reporting Requirements and Transparency

Reduction of Cash Transactions

Government Tenders

Databases and Information Gathering

Law Enforcement

Reforms and Amnesty

The Tax Code

Legal Issues

Customs and Duties

Public Campaign

Additional sections in the report :

The Orientation of Macedonia (equidistance, EU, NATO, Balkan)

The Budget

Data and Statistics

The media

Pensions Social and Welfare Benefits


Information and Knowledge – infrastructure and industries




Transportation and Telecommunications

Tourism and Catering

The Capital Markets

Foreign Direct Investments