In the early hours of a typically cold February morning, Russian artillery fire broke the lull in eastern Europe, marking the beginning of a conflict whose reverberations will be felt in global security, political and economic corridors.
The war in Ukraine, the grim culmination of long-running, simmering geopolitical disagreements among the great powers, has tectonically disrupted a complex web of geo-economic flows that reach far beyond the war-torn regions of Eastern Europe.
While the financial markets tremble under the weight of the new uncertainty that the war brings with it, the countries are once again drawn into an unfathomable series of economic problems: supply chain disruptions, a jump in the prices of basic goods and services, and a significant reversal in international trade dynamics.
Fiscal upheavals, caused by the war in Ukraine, have undeniably spread across continents and accelerated the saga of the necessary recalibration of the global public debt, which was already burdened by a difficult struggle against the consequences of the merciless pandemic of the covid-19 virus.
Until now, there has been no research into the impact of international factors, such as the war in Ukraine, on the change in state revenues in Montenegro, which provided an opportunity to investigate this topic in more detail.
Thanks to modern methods of statistical modeling, thanks to the monthly GDDS of all budget items from 01.01.2014 to 31.08.2023, projected revenues were modeled and compared with realized revenues. An analysis of the effects of the Ukrainian war on key segments of Montenegro's budget revenues, including value added tax, profit tax, excise taxes, and contributions to the Pension and Disability Insurance Fund of Montenegro, was conducted.
According to these data, from the beginning of the war (February 2022) until August 31, 2023, about 338 million euros more than the projected budget revenues for these four categories of revenues were paid into the budget of Montenegro. It can be concluded that the war in Ukraine is the main cause of increased budget revenues in 2022, and especially in 2023, when for the first eight months, as many as 257 million euros more than the model projected budget revenues were collected.
But let's start in order, this story is quite complex.
Description of the used methodology
In the current period of global economic unpredictability, intensified by the war in Ukraine, the process of planning government revenues in Montenegro becomes an extremely demanding task that goes beyond the simple use of linear regressions and trend analysis.
In the complex economic context faced by Montenegro, which is largely shaped by significant demographic changes due to the war in Ukraine (migration of 120.000 citizens mainly from Ukraine and Russia, but also from other countries, which makes up 20% of the total population of Montenegro) , the application of sophisticated statistical models is necessary.
These models efficiently combine historical data with algorithms designed to process and interpret a large number of variables, which contributes to more accurate economic forecasts. Also, they enable quick adaptation to changes in real time and offer a platform for assessing potential economic risks through detailed analysis of different scenarios.
This approach is of vital importance for the projection of budget revenues, which are key to activities in cost planning, public investment management and projection of fiscal flows.
Bearing the above in mind, during the preparation of this analysis, in the modeling process itself, various statistical models such as ARIMA, ARIMAX, ADL, linear regression models, structural econometric models as well as some of their combinations were tested, all with the aim of obtaining a model with the best performance of projections.
In addition to the testing of various statistical models, a significant number of scenarios of the projections themselves were tested. After the testing phase, the selection of the final model was reduced to several optimal ARIMA models that were evaluated for the period from 2014 to 2019.
A significant increase in income compared to the model projected
The final data of the analysis indicate a significant increase in realized budget revenues compared to the model of projected revenues. For the graphical representation of the obtained results, four graphs were created that illustrate the mentioned budget revenues.
Each graph consists of several identical components:
- the black line representing the realized income from 01.01.2014. until August 31.08.2023, XNUMX,
- the blue lines represent the projected level in relation to historical data,
- the "War in Ukraine" zone, which begins on February 01.02.2022, XNUMX. years.
Value added tax
The first graph, "VAT Advanced Forecasting", indicates a significant increase in VAT revenue due to the impact of the war in Ukraine, resulting in better than expected VAT collections based on a model using data starting in 2014. .
In the period from February to December 2022, an increase in VAT revenue by 70 million euros was recorded compared to the value projected by the model. This growth was further strengthened in the first 8 months of 2023, with an increase of 93 million euros above model projected values.
Overall, in the period from February 2022 to August 2023, VAT revenues exceeded the values projected by the model by an impressive 163 million euros.
The most significant factors that contributed to this increase in VAT revenue are the war in Ukraine, which led to the migration of over 120.000 citizens from Russia, Ukraine and other countries to Montenegro, high double-digit inflation, and finally, the "Europe Now 1" program. , which had the least impact on such a high increase in VAT collection compared to the value projected by the model.
Excise duties
The second chart, “Advanced Excise Forecasting,” reflects the effects of the Ukrainian conflict on excise revenues, which differed from those anticipated by the model based on 2014 data.
In the period between February and December 2022, excise revenues were lower by 34 million euros compared to model projected values. This deficit is a consequence of the decision of the Government of Montenegro from May 2022, to reduce excise duties on fuel, as a measure to mitigate the effects of price increases on the economy and the standard of the population.
However, a reversal was observed in the first eight months of 2023, with excise revenue increasing by 21 million euros compared to projections.
Overall, from February 2022 to August 2023, revenues from excise taxes are EUR 12 million less than what was projected by the model. The main reason for this decrease in excise tax revenue is the previously mentioned reduction of excise rates by the Government of Montenegro.
Profit tax
According to the third graph, "Advanced Corporate Tax Forecasting", there is a noticeable increase in corporate tax revenue that has been fueled by the war in Ukraine. This led to better results in tax collection than projected by the model using data from 2014.
In the interval from February to December 2022, a moderate increase in income from profit tax was achieved, which amounted to 1,2 million euros more than projections. However, there is a marked increase in the first half of 2023, with income from corporate tax exceeding expectations by a significant 62 million euros.
In total, from February 2022 to August 2023, income from corporate tax exceeded projections by an impressive 63,2 million euros.
Factors such as the war events in Ukraine, which caused the migration of more than 2023 people from Russia, Ukraine, and other countries to Montenegro, high inflation, and to a lesser extent , the impact of the "Europe Now 120.000" program.
Contributions for PIO
The fourth graph "Advanced Forecasting of PIO Fund Contributions" reveals an impressive growth in income from pension and disability insurance contributions, which was caused by war events in Ukraine. This growth exceeded expectations set by the model, which relies on data collected since 2014.
In the period from February to December 2022, income from contributions to the PIO fund increased by 44 million euros compared to projections. This growth tendency became even more pronounced during the first 8 months of 2023, when an increase in income for the PIO fund of an additional 81 million euros was recorded above the projected values.
In total, in the period between February 2022 and August 2023, income from contributions to the PIO Fund significantly exceeded expectations, by 125 million euros.
A sharp and sudden jump in apartment prices creates a lot of pressure not only on those who rent apartments, but also on those who strive to solve the housing issue. With prices reaching up to 3.000 euros per square meter in Podgorica, buying an apartment becomes unattainable for the average citizen of Montenegro.
The most important factors that led to this increase in income are the war in Ukraine, which led to the migration of more than 120.000 people from Russia, Ukraine and other countries to Montenegro who established a working relationship and made payments for contributions to the PIO Fund.
Summary results of the analysis
A comprehensive review of budget revenues, united in a single table, from February 2022 to August 31.08.2023, XNUMX. year, we observe a significant additional accumulation in the four main categories of state budget revenues (VAT, excise taxes, profit tax and contributions to the PIO Fund) compared to the value projected by the model.
In total, revenues exceeded the model's projected value by 338 million euros, with growth of 81 million euros during 2022 and an exceptional increase of 257 million euros in 2023.
It can be expected that in 2023, these 4 income categories will grow to around 380 million euros compared to the model projected.
Therefore, the extremely high collection of budget revenues, especially in 2023, is to the greatest extent the result of a "one-time" external event (the war in Ukraine) and the arrival of over 120.000 people, who to the greatest extent have strong purchasing power (they spend as much as 250.000 citizens of Montenegro ), which creates huge distortions on the Montenegrin market and to the detriment of the largest number of Montenegrin citizens who, because of this fact, pay higher prices for goods and services, with a special emphasis on the enormous increase in the price of apartments, both for sale and for rent.
In addition to the war in Ukraine, double-digit inflation, as well as the Europe Now 1 program, which had the least impact compared to the first two factors, are responsible for the increase in the mentioned categories of income.
From the analysis, the following forecast can be made: when the war in Ukraine ends, the currently "overheated" economic activity and high budget revenues in Montenegro will "cool down" and return to lower, normal limits. If there is a significant increase in budget expenditures, as planned by the Europe Now 2 program, in a short period of time there will be a huge imbalance between income and expenditures. In that case, the state budget will very quickly record extremely high deficits, which can be financed by new debt at high interest rates and which will not be able to be contained in the medium term.
This development of events can be irresistibly reminiscent of the Argentinian scenario characterized by fiscal irresponsibility, deficit financing with expensive loans, dependence on external financing, increased poverty, which ultimately can lead to investor distrust for public debt financing.
Negative consequences for citizens
Although strong positive effects on budget revenues are noticeable, there is also an obvious negative impact of the war in Ukraine on the citizens of Montenegro. High food prices are the result of high fixed trade margins applied to already rising import prices. Also, the prices of other goods and services are rising significantly, which results in a decline in the real purchasing power of the citizens of Montenegro.
One of the many indicators of the negative effect of the Ukrainian conflict on living standards is the increase in real estate taxes. Comparing this year's decision on real estate tax with last year's, it can be noted that citizens are obliged to pay about 20% more real estate tax, which is a direct consequence of the intense jump in real estate prices, caused by the arrival of a huge number of citizens from Russia and Ukraine.
A sharp and sudden jump in apartment prices creates a lot of pressure not only on those who rent apartments, but also on those who strive to solve the housing issue. With prices reaching up to 3.000 euros per square meter in Podgorica, buying an apartment becomes unattainable for the average citizen of Montenegro.
The context of expensive borrowing and the possible Argentine scenario
The current global economic context is dominated by high inflation rates associated with elevated interest rates that affect state finances, company operations and the economic power of citizens. Increased financing expenses borne by companies usually result in increased prices borne by end consumers. In addition, citizens face higher interest rates on housing and consumer loans, which reduces their ability to spend.
Rising interest rates on public debt put pressure on fiscal capacity to implement necessary reforms, especially if debt servicing costs exceed or reach the growth rate of gross domestic product (GDP). Forecasts by international financial institutions indicate that the growth rate of Montenegro's GDP will be around 3%, while the cost of interest on the public debt in 2025, when the "Europe Now 2" program is planned to begin, will exceed this rate.
Therefore, when considering an ambitious, never-presented economic program such as "Europe Now 2", which aims to significantly increase average salaries (to 1.000 euros) and average pensions (to 600 euros) through the abolition of contributions to pension and disability insurance, and reaching full employment within a short period of 12 months, it is essential to take into account the complex financial and economic circumstances in which Montenegro finds itself.
The rapid introduction of such a radical program of reforms in Montenegro will require considerable funds, especially if it is planned to abolish contributions for pension and disability insurance, which will result in reduced revenues for the budget that cannot be replaced from other stable and predictable sources.
Since one of the sources of financing for Montenegro is foreign market borrowing, the challenges they face are multiple:
1. Debt refinancing: if we know that Montenegro has to refinance around 2,5 billion euros of debt by 2027, with expected higher interest rates, this will significantly put pressure on additional debt and increase debt costs,
2. Interest costs: in the next 4 years, we will pay over 700 million euros in interest on the public debt, which will greatly burden budget expenditures. If interest rates rise, as expected, the amount allocated to interest will be even higher.
3. Budget deficit and narrow fiscal room for maneuver: apparently, the interest rates at which the public debt will be refinanced will be higher than 7%. The additional cost of interest will limit spending on other programs. As the debt interest rate is higher than the GDP growth rate, with increased expenditures for increased salaries, pensions and employment, the risk of a significant budget deficit increases.
Unpreparedness of investment projects
As part of the narrative about infrastructure projects and their impact on the economy, it is important to highlight the fact that investments in infrastructure are crucial for economic development, but their realization requires a significant amount of time due to various factors, of which I list the following:
1. The complexity of planning and designing projects: the preparation of feasibility studies, geotechnical investigations and environmental and social assessments requires thorough work and considerable time,
2. Regulatory framework: the processes of obtaining the necessary permits and approvals can be lengthy due to the complex bureaucratic system and potential legal challenges,
3. Financial complexity: ensuring an adequate method of financing is a complex task considering the large amounts required and the expected changes in the financial markets in the form of high interest rates that reduce the financial sustainability of investments,
4. Technical challenges: every infrastructure project carries unique technical challenges that require specialized knowledge that can slow down the execution of the investment,
5. Coordination with stakeholders: numerous stakeholders must agree on their goals and priorities, which is a process that requires time and careful management,
6. Impact on the local community and the environment: projects must also take into account the potential impact on the local communities and the environment, which includes consultations and plans to mitigate negative effects.
Therefore, investments in infrastructure are processes that do not tolerate speed; due to its complexity and importance for society, the implementation of such projects requires detailed planning, interdisciplinary coordination and consideration of long-term implications.
When we talk about the current situation with infrastructure projects in Montenegro, it is important to point out that the projects do not have a good level of preparation, which is necessary for quick implementation. Thus, in the latest instructions for the preparation of the Program of Economic Reforms for the period 2024-2026. year, in the part related to investments in public infrastructure, the following is stated: "Implement the recommendations for the assessment of public investment management (PIMA) giving priority to key public infrastructure works within the available fiscal space, while avoiding exceptions in terms of project selection".
In the mentioned PIMA report, it is clearly emphasized that in Montenegro, the effectiveness of fiscal rules, national and sectoral plans, project evaluation and the effectiveness of multi-year planning are at a low level.
Therefore, fulfilling the recommendations from the PIMA report will require time, professional knowledge and serious coordination between departments, which cannot be implemented in a short period of time.
In this context, we should also recall the situation we had with the project for the construction of a priority section of the highway, which was contracted outside the public procurement system, was non-transparent and shrouded in secrecy, permanently devastating the environment and ultimately was completely financially unprofitable. I hope that we will not repeat a similar mistake when designing the implementation of future infrastructure projects.
When looking at the unique list of infrastructure projects (JLIP), which includes over 150 projects worth around 6 billion euros, it is noticed that the largest number of projects are poorly prepared for rapid implementation.
I'll take the Adriatic-Ionian highway as an example: according to the data from the JLIP list, out of the billion euro investment for its construction, category 2c includes a total of 4 subprojects, worth 700 million euro. Translated into a language understandable for citizens: 70% of the investment is classified in the worst category according to the level of readiness of the project for financing. Also, the situation is not better for other sections of this expressway, which are classified in category 2b: two sections worth 244,4 million euros also have significant problems in readiness for financing.
It is clearly visible that most of the projects on this list currently do not meet the conditions for co-financing from the European Union funds. This implies that, if there is a desire for accelerated implementation, their financing must be provided from the state capital budget. However, the current trend of rising interest rates should be taken into account, which can potentially affect the economic justification of these investments.
Conclusion
From the described facts, a clear conclusion can be drawn that the extraordinary, external event (war in Ukraine) led to positive economic flows for the state budget, which resulted in a strong growth of four categories of budget revenues, especially in 2023.
When the war in Ukraine ends, budget revenues will return to predictable, lower levels while current expenditures will remain high, causing a huge deficit in public finances that will have to be financed by high-interest debt.
A massive, radical and rapid reform of the announced abolition of contributions to the Pension and Disability Insurance Fund, which now amount to over 500 million euros annually, from which salaries will increase linearly without increasing productivity, and which is planned to be implemented in a short period of 12 months, in combination with the announced increase in average pensions (additional cost of 250 to 300 million euros annually) and the attempt to reach full employment (unclear in what way), will represent a noose around the neck for public finances when the war in Ukraine ends.
Basing an extensive and radical reform on an extraordinary external factor that in the previous two years had a positive impact on budget revenues, at a time when we are expected to incur significant debt at high interest rates in order to refinance the old and finance the new debt (deficit), represents a short-sighted and inadequate public policy which is not based on data and facts, but is the result of unfounded adventurism that will cost Montenegro and all its citizens dearly in the medium and long term.
The author is the executive director of "Fidelity consulting"
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