Monday, January 28, 2008

Macedonia's Report Card - 10 Things that Could Go Wrong

Like Blanche Dubois in "Streetcar Named Desire", Macedonians now prefer fantasy over harsh reality. They lash against anyone who wishes to offset their euphoria with a long, hard look at hazards, real achievements, and true future prospects.

Under the tutelage of the Gruevski government, Macedonia made great strides in a surprisingly short period of time. The government should be lauded and complimented for its energy and initiative and its inordinate ability to transform Macedonia into a modern participant in globalization. The pace and extent of its accomplishments in incredible.

Yet, Macedonia faces 10 risks and the government is doing precious little to confront them:

1. Asset Bubbles

At a multiple of 37, the Macedonian Stock Exchange is a bubble, by any definition of the word.

The Macedonian Stock Exchange, as measured by its MBI-10 index, rose to a record high of close to 10,500 in mid-2007. It has since shed 30% of its gains. This correction, or, rather, rout has its roots is a series of converging factors.

Macedonia benefited from globalization. As its informal economy emerged from the shadows, capital controls were lifted, capital mobility increased, and foreign firms and investors entered the scene. The more the business climate improved, the better Macedonia's prospects appeared, the higher Macedonian stocks were valued by an euphoric public. Macedonia's professionals did nothing to restrain the hysteria or to ameliorate the casino mentality that pervaded the entire system. They benefited personally from the bubble.

The newfound optimism of Macedonia led to a repricing of risk and to heightened expectations of corporate profits, boosted by a more lenient tax regime and by decreasing interest rates. Equity risk premium plummeted until it vanished altogether and even became negative. The P/E multiple reached a stratospheric 50 before the recent correction. It is still pegged at an unsustainable 37.

Throughout this Bacchanalia, foreigners flocked into the Macedonian Stock Exchange, constituting 30-40% of the buy side. But they have begun to withdraw owing to big privatizations back home, troubles in their domestic financial systems, a more restrictive monetary policy in some countries, and the changing fortunes of the Macedonian marketplace.

The down trend in the Macedonian Stock Exchange is not a mere correction. It is a repricing of assets. It still has a long way to go. Even at 4300 - the next massive technical support - Macedonian shares are inanely overvalued.

Similarly, real estate prices are stratospheric, but this can be justified by the lack of reliable, scandal-free supply and the underdeveloped market for mortgages and real estate leasing.

Should one or both bubble burst, the adverse effects on consumption are likely to be noticeable.

2. Credit Bubble

In December 2007, holiday spending in Macedonia surged 100 million euros to 350 million euros. Most of the increase was financed with credits, as were the purchases of shares on the stock exchange, cars, and housing. High interest rates virtually guarantee that many of these loans will go bad. When they do, the government will be called upon to bail out the banking system. In all probability, it will.

3. Trade Deficit

Macedonia's trade deficit now equals 15% of its formal GDP (excluding the informal economy). It is unsustainable. Yet, the more vigorous the economy, the more the country's consumers and businessmen are likely to import. The culprits in engendering this imbalance are an overvalued currency, a hyper-liberalized trade regime, an antiquated and badly-managed industrial sector, and the profligacy of the population.

As long as unilateral transfers (such as remittances) cover the yawning gap in the current account deficit, Macedonia can survive with such irresponsible conduct. But, if the global economy turns sour, Macedonian Gastarbeiter will be forced to return home. This will likely precipitate a currency crisis.

4. Living Standards and Inflation

Inflation in Macedonia is severely under-reported by the government's Bureau of Statistics. Even so, living standards have dived with the rise in energy and food prices. The government doles out wage and pension increases but cannot compete with the global surge in the prices of commodities. Coupled with the aforementioned credit bubble, this is an ominous sign. Macedonia could end up having its own mini-version of the crisis in the USA: bankruptcies, credit crunch, and recession.

5. Foreign Direct Investment (FDI)

While Macedonia's image and perception as a business destination and the business climate have improved considerably under Gruevski's government, in reality, not much else has changed.

Consider the following numbers, pertaining to Macedonia:

Control of Corruption Indicator, published by the World Bank: 113 (2006) vs. 111 (2007)

Country Credit Rating, published by Institutional investor: 85 (2006) vs. 84 (2007)

Index of Economic Freedom, published by The Heritage Foundation and the Wall Street Journal: 75 (2006) vs. 71 (2007)

Quality of National Business Environment Ranking, issued by the World Economic Forum in its Global Competitiveness Report: 87 out of 121 countries.

Only the World Bank's Doing Business Ranking jumped from 96 (2006) to 75 (2007). Yet, even this indicator hides some unpalatable truths: Macedonia has deteriorated in certain respects. It is more difficult and cumbersome to hire workers, to register property, to obtain credit, to protect investor rights, and to enforce contracts. In any case, this indicator has more to do with public relations, expectations, and psychology, rather than with the hard facts on the ground.

And the hard facts are:

Macedonia is not ready to absorb and accommodate foreign investors and their capital. It still has a long way to go. This government has put the cart before the horses;

The youthful, populist, and inexperienced administration is overwhelmed and ill-equipped to deal with its obligations towards and promises to foreign investors. Decision-making bottlenecks (especially in the office of Vice-Premier Zoran Stavreski) conspire with red tape and blatant favoritism to render nightmarish both greenfield and brownfield ventures.

In a long-running arbitration, the country was slapped with multimillion dollar damages payable to the Greek investors in Okta. This did not deter the government from conflicting vocally and publicly with Macedonia's other large investor, the Austrian EVN, owner of the electricity utility;

To its credit, the government has reformed the tax system, introduced a flat tax, and reduced the tax rates, all laudable. But it is still illegal for foreigners to own land and real estate (as individuals) and all but impossible to trade in the local stock exchange. The government has only now resorted to tackling these archaic limitations;

The country is dysfunctional. No institution works properly: the cadastre, the courts, law enforcement agencies, the civil service are all in chaotic disarray. Even the banking system, despite a decade of FDI, is rudimentary. Infrastructure of all sorts is dismal, though improving. The government's anti-corruption drive is much lauded but highly politicized and one-sided, aimed as it is exclusively at the hapless politicians of the opposition. Macedonia's laws are not geared to welcome and assimilate foreign investment, foreigner businessmen, and foreign workers;

Macedonia lacks skilled manpower. The education deficit is pervasive. More than half the adult population has eight years of schooling or less. A multi-generational brain drain saps the country's vitality and prospects in the global information economy of the 21st century. Contrary to the government's claims in its "Invest in Macedonia" campaign, costs and taxes associated with wages are among the highest in the world.

The country suffers from other problems: a huge informal economy, skyrocketing consumer and enterprise indebtedness, ominous asset bubbles in both the stock exchange and the real estate market, a crippled middle class and crippling poverty and unemployment rates, an unmanageable and increasing trade deficit (c. 15% of GDP), and a whopping current account deficit offset only by remittances from Macedonian workers abroad. The global credit crunch constitutes a major threat to polities with such precarious finances.

Despite a slew of expensive PR and advertising campaigns; the appointments of two ministers and the formation of a special agency to deal with FDI; incessant trips abroad by every functionary, from the prime minister down; and innovative marketing initiatives - FDI figures for 2007, at c. 180 million USD (c. 3% of GDP), are a major disappointment. Moreover, a sizable part of Macedonia's FDI is in construction, retail, financial services, and trade, economic sectors with minimal contribution to future growth.

In comparison, FDI doubled in decrepit, post-bellum Serbia, to 4.5 billion USD in 2006. Croatia garnered 3.6 billion USD (2.7 billion euro) - twice the 2005 figure. Even strife-torn Bosnia-Herzegovina, under a EU peacekeeping mission, attracted 2.9 billion USD (2 billion euros). Bulgaria absorbed 6.5 billion USD. FDI amounted to 10% of Balkan GDP in 2006.

The conclusion is inescapable: Macedonia has failed in its bid to attract FDI. This is not the first time that Macedonian politicians and their downtrodden and destitute people prefer the fantasy of foreign saviors to the hard slog of painful and much-needed reforms at home. The current prime minister, Gruevski, served in the government of Ljubco Georgievski, whose nostrum and panacea to Macedonia's economic woes was dollops of money, supposed to be funneled via illusive Taiwanese investors. The person most identified with this policy, Vasil Tupurkovski, now faces criminal charges.

Gruevski can learn many lessons from the debacles wrought by his predecessors. It is not too late to get his priorities straight: reforms, education, domestic investment, and employment first, and only then an open invitation to foreigners to come and invest in Macedonia.

6. Geopolitical Risks

Geopolitical instability (in Kosovo) is exacerbated by the current Macedonian regime's jingoism, its overt and manipulative religiosity, and greenhorn fickleness. Within the last year, Macedonia has considerably retarded its chances to enter NATO and the European Union (EU), having clashed unnecessarily and spectacularly with Greece, Serbia, Bulgaria, and the Albanian minority at home.

7. Unemployment

The government's obsession with FDI as the solution for Macedonia's unemployment precluded a reasoned and coordinated effort to tackle unemployment head-on, especially by encouraging domestic investment. To this very day, the government has failed to come with a plan on how to fight unemployment in the short to medium term.

Consequently, unemployment has remained largely the same, at 35%. In certain sectors - such as mining and manufacturing - it even went up (by a whopping 8%, compared to 2005).

The government's concurrent attempts to fight the informal economy have the unfortunate effect of removing the only effective social safety net and source of income available to the unemployed.

8. Education

As is its habit in all other fields, the government is more concerned with grandiose schemes (computer for every child) than with the mundane and dreary reality of education in Macedonia: lack of infrastructure, no teaching cadre, no supportive social services (day care, for instance), or cultural ambience (the education of girls is still controversial in certain segments of Macedonian society).

The government is attempting to respond to the perceived needs of foreign investors by teaching skills to young and older alike. This is a step in the right direction. But, carried out in a vacuum of other policy measures, it is bound to backfire and end in a brain drain or in deep and lasting frustration.

9. Agriculture

Instead of acknowledging that Macedonia's agriculture is non-competitive for a variety of reasons, the government keeps pouring tens of millions of scarce euros into dying crops (tobacco, for instance). The solution is, of course, to scrap the entire Macedonian agriculture, retrain the farmers and embark on a bold plan to reorient the sector to off-season vegetables and flowers, high-value crops, organic produce, and bioengineering.

10. Over-taxation

When a government in a country as destitute as Macedonia wastes its money on the early repayment of debts to International Financial Institutions and ends up with a surplus in its central budget, its policies are wrong and constrictive. Rather than promote growth, the government is over-taxing. This leads to an inefficient allocation of resources. Rather than invest, the government increases wages in the public sector, augments pensions, and showers subsidies on dying sectors.

Paradoxically, such colossal waste is bound to end up in a demonetization and contraction of the economy as the private sector gives up its futile attempt to compete with the largesse of the government and as businesses are rendered rent-seekers.


The Gruevski government is business-friendly and growth-oriented. It is truly reformist. However, its policies of benign neglect and over-reliance on foreigners and their money as a nostrum and panacea threaten Macedonia with stagflation: inflation coupled with recession, increasing unemployment and negative growth.

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