MINISTRY OF FINANCE OF MONTENEGRO

MONTENEGRO

ECONOMIC AND FISCAL PROGRAMME

2009 – 2012

Podgorica, January 2010

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TABLE OF CONTENTS

1. ECONOMIC POLICY FRAMEWORK AND GOALS...........................................................32. ECONOMIC FRAMEWORK................................................................................................9

2.1. ANALYSIS OF THE MACROECONOMIC TRENDS IN MONTENEGRO IN 2008 AND WITHIN THE PERIOD FROM JANUARY TO SEPTEMBER 2009.........................................................................9

2.1.1. Gross Domestic Product.......................................................................................102.1.2. Inflation.................................................................................................................122.1.3. Labour market.......................................................................................................132.1.4. Banking sector......................................................................................................132.1.5. Balance of payments............................................................................................17

2.2 MEDIUM TERM MACROECONOMIC SCENARIO...................................................................202.2.1. Map of Risks Relevant for the Montenegrin Economy 2010-2012.......................212.2.2. “Base Scenario” vs. “Crisis Scenario”...................................................................23

3. PUBLIC FINANCES..........................................................................................................333.1 PUBLIC FINANCES SECTOR – FISCAL FRAMEWORK AND DEBT MANAGEMENT....................35

3.1.1 Public Finances Trends in the Period 2008 - 2009...............................................35 3.1.2. Fiscal risks in 2010..............................................................................................39 3.1.3. Goals and basic directions of the fiscal policy in the following medium term framework......................................................................................................................40 3.1.4. Medium term fiscal framework for 2010 – 2012....................................................423.1.5 Public Debt Management Strategy......................................................................47 3.1.6 Budget implications of main structural reforms......................................................54

3.2 PUBLIC FINANCES QUALITY..............................................................................................563.3 PUBLIC FINANCES INSTITUTIONAL FRAMEWORK................................................................57

4. STRUCTURAL REFORMS OBJECTIVES........................................................................594.1. ENTERPRISE SECTOR....................................................................................................59

4.1.1. Privatisation..........................................................................................................594.1.2. Competition, state aid and public procurement....................................................614.1.3. Business environment including tax aspect..........................................................644.1.4. Network Industries................................................................................................71

4.2. FINANCIAL SECTOR........................................................................................................874.2.1. Banking sector.....................................................................................................87 4.2.2. Non-banking sector..............................................................................................93

4.3. LABOUR MARKET.........................................................................................................1004.4. Administrative reforms..............................................................................................106

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1. ECONOMIC POLICY FRAMEWORK AND GOALS

Implementation of the Euro-Atlantic Agenda that will eventually be materialized through the membership in the EU and NATO does not represent only political commitment, but also a type of external anchor for the purpose of completing the transition process that will enable the citizens of the country to better their living standards and life quality in general. To that end, it is important that Montenegro received in July 2009 the Questionnaire of the European Commission as a next step towards the membership in the EU, and then Montenegro delivered the answers in December 2009. By answering additional questions expected to come, the conditions will be created for the European Commission to form the opinion, in the period to come, about the possibilities of Montenegro to acquire the status of candidate and certainly to start negotiations about the membership.

Comprehensive economic reforms and the development concept based on private ownership, market principles, openness, free flow of capital and competitive tax policy made that the Montenegrin GDP rose by 60% in 2005, compared to the year of 2000. The renewal of the independence represented an accelerator of economic growth, and the GDP in 2008 tripled compared to its value in 2000. At the same time, the GDP was restructured in favour of the service sector, with increasingly important role of small and medium-size enterprises, the vitality of which at the time of economic crisis has become an important test of vitality of the entire economy in the long run. However, a key challenge in the period to come is further restructuring and reforms in the public spending segments such as state administration, and the systems of education and health.

Responses to the economic crisis. Economic growth in Montenegro, with the average real rate of 8.7% from 2006 to 2008, was interrupted by negative effects of the global economic crisis. Although the first consequences in most countries were visible already in 2008, Montenegro had even then high real growth rates. Negative delayed global economic crisis effect in Montenegro overlapped with a slight recovery of the world economy, which was eventually reflected through the estimate of negative GDP growth rate of 5.3% in 2009. Economic activity downturn led to the budget deficit which was estimated to 4.0% of GDP for 2009. Due to the fall in aggregate demand, inflation reduced in 2009 and it was estimated to be below 2%, whereas the unemployment rate was kept at the level similar to the level of the previous year.

Montenegro, as an open and import-dependent system, faced the first signs of the crisis at the end of 2008, when it started the implementation of the set of measures in order to mitigate it. In the spirit of the implemented measures, it has also provided, on one hand, the support to the sound business, with the necessary measures regarding restructuring of the largest industrial systems, whereas, on the other hand, a focus has been the social sustainability of the Montenegrin society in the long run.

The use of the euro as a legal tender in Montenegro, introduced after the economic crisis of the nineties of the last century and the consequences of the hyperinflation, was the initial step in achieving the macroeconomic stability. At the same time, the use of the euro as a legal tender made impossible the use of most quantitative instruments of monetary policy during the financial and economic crisis, making the mandatory reserve rate the only means that can to some extent control the secondary issue. On the other hand, the use of the euro prevented the rapid aggravation of the level of real income in case of assumed accelerated

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depreciation of the local currency, which would additionally deepen the consequences of the economic crisis in the long run and incite social tension in the short run.

In order to stimulate credit activity of banks and overcome the liquidity crisis in the financial sector (caused primarily by withdrawing of deposits), and then in the real sector, the mandatory reserve rate was reduced in June 2009 from 19% to 10%, which is applied only to sight deposits and term deposits. In December, the Central Bank additionally considered the policy of provisions for placements for the purpose of faster rehabilitation of the banking sector and creating the conditions for renewing the crediting of small and medium-size enterprises, bearing in mind the negative increase of credit placements in 2009.

The measures taken by Montenegro as the response to the crisis mostly rely on the fiscal policy instruments. The State guaranteed by the Law on Measures for the Protection of the Banking Sector, in addition to the other measures whose goal was urgent reaction in case of larger disturbances on the banking market, 100% of households and corporate deposits. In such a manner, with the first signs of consequences of the crisis in other countries, the State tried to avoid a negative impact implied by households and corporate sector’s expectations.

Fiscal policy measures are dominantly directed to the expenditure-side of the budget and reducing the expenditures of the public sector. One of the revised expenditures was the total wage bill of the public sector. It is estimated that it is possible to restructure the level of employees in the mid-term, so that the wage bill has been rearranged in order to reduce the total costs, and the net wages were reduced. The planned savings in 2010 on the basis of the reduction of gross wages of employees in the public sector are approximately 15 million euro, which is 4% less compared to the amount envisaged by this item in case the regulations were not changed. On the revenues side of the budget, amendments to the laws will create the inflow of funds on the basis of the reduction, holidays and exemptions in case of personal income tax, as well as the increase of the base of corporate profit tax from 50% to 100% for the capital gains. One of the Government priorities is further improvement of the business environment, and the goal of the State is to keep, with the fiscal policy measures, as favourable as possible investment and business environment that would encourage the entrepreneurship at the time of the crisis.

Challenges. The global economic and financial crisis has disrupted the achievement of long-term goals and has set different bases. In spite of slight economic recovery projected for 2010, Montenegro will face in the middle term a set of challenges caused by the crisis, as well as structural imbalance in the economy. Currently, the following can be distinguished:

Liquidity crisis is the main cause of the low investment and personal consumption that led to the economic downturn. This problem is even greater if we take into consideration the downturn of investment activity on the world market and restrictive credit policy of banks in Montenegro. Although net investments are at a higher level than expected in this crisis year of 2009, their incentives and growth in the following years primarily in the sector of small and medium-size enterprises will have the largest impact on the growth of productivity, and consequently on employment and aggregate demand. The Government of Montenegro has undertaken a set of measures to face the problem of general illiquidity and create the environment for investment growth. One such measure is to restrict current public spending (if donations and programme loans are excluded from the balance of the current budget, it can be concluded that it has a structural surplus) and to keep a high share of capital expenditures. Although by doing so, the conditions for the State budget sustainability are primarily created, and the fall in wages may cause additional drop in liquidity in the short run, the State has chosen to take the measure that will not significantly affect the increase of taxes to solve short-term budget problems, thus reducing already pronounced liquidity problem of the economic sector that includes the majority of

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total employees. On the other hand, the goal of measures to improve business environment is to eliminate business barriers and give Montenegro a place on a ranking list that will be a positive signal to every future investor regarding his decision to invest. Structural reforms in the area of health, education and labour and social welfare tend to rationalize, increase efficiency and open greater possibilities for introducing the private sector to perform public services. By encouraging the private sector and by increasing efficiency of the state administration, the productivity and the growth of wages from productivity are increased and consequently aggregate demand is increased, which potentially leads to higher growth of investments.

Foreign trade deficit, together with economic growth, represents a constant problem of the Montenegrin economy during the recession as well. It was to be expected that a small country at the time of expansive economic growth would satisfy the increased investment and final demand from the import. However, a significant and constant share of some goods in the import may be an initial signal of high demand for such goods. If Montenegro has adequate resources, the import of such goods could be compensated by their production in Montenegro. In such a manner, the import-dependability would be reduced and the basis would be created for the growth of competitiveness. Resources for the production of competitive products that could be offered on the domestic and foreign market (including a million of foreign tourists per year and foreign investors) are in the areas such as energy, agriculture, wood industry, production of construction material and similar. Measures for encouraging entrepreneurship and successful and sound companies within the small and medium-size business, creation of favourable business environment with no business barriers, and promotion of Montenegrin products on the domestic and foreign market, and projects in these areas may generate growth of the overall economy and reduce import dependence.

Regional development imbalance as a consequence of the developed south and the undeveloped north of Montenegro was especially pronounced during the economic boom and faster economic growth of the south than the north area. Balanced economic development of all regions represents a challenge of all economic growth and development strategies. The construction of new energy facilities, Bar-Boljari Highway, the incitement of entrepreneurship, the incentive policy for employment and development of small and medium-size enterprises, opening of university units in northern municipalities, and rural development policy, mark the beginning of the process of reducing the development differences of the region. However, the goal for developing the north of Montenegro should not be equalization with the development of the south, but exploitation of the potentials whose productive use is at extremely low level. In the following period, the policy for the north development should be directed to stimulating young population to find an interest in education, work and forming families in their place and municipality of birth. To that end, the support for the development of the north should be through the strengthening of educational, administrative and economic capacities in the area of energy and mining, agriculture, wood processing and tourism.

Structural unemployment has occurred as a pronounced problem during the economic boom in Montenegro. The growth of demand for labour force, on one side, and constant long-term unemployment of people having certain qualifications, on the other side, are still the characteristics of the labour market of Montenegro at the time of the economic crisis. However, the structural unemployment is a problem and challenge for Montenegro that needs to be faced with now in a proper manner in order for the economic growth to be supported by adequate labour market and reduction in the unemployment rate.

The national employment strategy and a set of documents that create employment policy assume the application of measures that primarily relate to the harmonization of the

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education system with the needs of the labour market, life-long learning, encouraging the entrepreneurship and innovations and integration of the older population, women and disabled persons in the labour market. The vision for the development of the Montenegrin economy, the initiated and planned projects involving foreign and domestic investments and their further development, the path to EU integrations, encouraging the sector of small and medium-size enterprises, and reduction of public expenditures are the first signal for the system of education and labour market of the need for certain specialized knowledge and skills.

Recession as the possibility for starting a new development cycle. Every recession results in adjustment of the rules of the game, and brings new players and market games. Montenegro has realized that a reaction needs to be prompt at the time of crisis, and that long-term consequences of measures for its mitigation need to be taken into consideration. It is even greater danger if measures are taken that have short-term positive and long-term negative effects. Therefore, Montenegro tends to have a reform-based approach to measures it takes, in the manner to improve the basis for a sustainable economic growth and development after recession and create conditions for growth of investments and employment, taking into consideration groups that are in social need and the importance of the role of the State within that context.

Over the last 20 years Montenegro has gone through various phases of growth and development substantially conditioned by both regional circumstances and changes on the world economic scene. The path to its firstly economic and then State independence was followed by innovative, creative and often risky moves of decision makers. A small Montenegrin system, although it has natural predispositions, would have been hardly attractive for investors if economic reforms had not been implemented that have created the basic parameters of the economic environment as a competitive one compared to other countries in the region. By summing up the experiences, both positive and negative ones, the experiences regarding the transition, the economic boom and the recession, Montenegro is at the beginning of the new economic period. This is the moment when it is necessary to make moves and have sufficient capacity and consider the results in the long rum and based on several scenarios. Strategic orientation, directed to a continuing process of EU and NATO accession, is supported by a clear vision of improving the living standard of every single individual in Montenegro: to be a member of the European Union not only on a paper but also in everyday real life. The platform to achieve that goal is: rule of law, efficient administration, open economic system and specialization in certain business activities.

The approach of Montenegro to overcome the crisis will be primarily based on the following commitments:

The role of the State is crucial on that path. A good state organization will be limited to those activities that it is better at than the private sector. For a small country such as Montenegro, this is also important due to other reason: cost of public administration must be adjusted to a small number of citizens, i.e. taxpayers. The goal is to have the state administration that is efficient and productive in the tasks it performs, and to have good quality and efficient regulations not only as the basis for the development, but also as a factor of diversity in the globalized world. Fiscal reforms tend to create a positive business environment and encourage entrepreneurship, thus improving comparative advantages of Montenegro as investment destination. Structural reforms in the area of health, education and labour and social welfare and the creation of the opportunities to form a partnership between the State and the private sector will create the basis for efficient and effective system of public services and for further growth of investments. In other words, state administration will represent the means that will contribute to and not be an obstacle to the growth of the standard of living.

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Rule of law in the system such as the Montenegrin one is the condition for the survival and the growth of sound and sustainable investments. Efficient execution of contracts and protection of investors are the key elements of the economic aspect of the rule of law. A small country such as Montenegro, at the international level, cannot be an economic force. Starting the integration process represents a high quality manner for Montenegro to adopt and apply the rules and standards that will enable a faster and simpler flow of people and capital, and adjust them to the characteristics of its political and economic system.

Specialization in certain areas is an important precondition for the development of a small country in the globalized world. Bearing in mind quantitatively and qualitatively limited labour force, and in accordance with its economic system, geographic position and resources, as well as cultural heritage, Montenegro should be competitive and should specialize its human and material capital in order for the idea to become real. Although the largest share in GDP is metal industry, lack of competitiveness of Montenegro in this area at the international market and the problems associated with the relics of socialist economic structure and manner of thinking have influenced the direction of the development vision of Montenegro and adjusted it based on its comparative advantages in the region and beyond. Economic growth and development generators of Montenegro are the areas for the development of which Montenegro primarily has the base in the natural and geographic predispositions: tourism and energy. In addition to the aforementioned, Montenegro has resources for agricultural production, wood processing, production of construction material, mining and quarrying, building construction works and civil engineering construction works and trade. By systematic and competitive approach, these areas may be complementary to the development of tourism and energy as priority branches, and at the same time contribute to the total growth of the economy. The Master Plan until 2025 envisages that the development of tourism is the priority branch of economy that has generated over the past years 17% of GDP and 3.5% of capital investments, and it employed 13.5% of the total employees. The mission of the Plan is to create its own tourist profile, so that it would not be possible to confuse Montenegro as destination with another one because it will be unique as such. This will be achieved by the creation of high quality and diversified tourist offering in accordance with the contrasted geographic terrains and by prolonging the season throughout the year. The energy sector has been increasingly distinguished over the past years as a potential generator of the Montenegrin economy growth, on one side, and infrastructure-related support to the development of the overall economy and the society, on the other side. Montenegro is import-dependent as far as energy is concerned. However, by new investments in the Electrical Company of Montenegro (EPCG), and by starting large greenfield investments in 2010 in the area of exploitation of lignite, and by the construction of thermo and hydro energy plants, the new development phase of energy sector of Montenegro has been initiated. Although there are significant reserves of high quality coal, Montenegro as ecological country will be committed to renewable energy sources and the use of clean technologies in fuel exploitation. Currently, 20% of the total electrical energy consumption is covered by the electricity from renewable sources. By using only 50% of the total hydro-potential, envisaged by the Strategy, Montenegro will cover 25% of the total consumption by 2025. If we add to the aforementioned, the wind and solar energy, coal reserves and the importance of geo-strategic position of Montenegro from the aspect of gas pipeline networks, we are reaching the conclusion that Montenegro can go from import-dependency to exporter of electrical energy. In addition, every energy-related project is based on the sustainable development principles.

Openness of the economic system is a key of its success. Although the global crisis shows that inter-connection of economies means a negative multiplicative effect at the time of recession, Montenegro must build its strength on the openness as well. The target market of Montenegro is far beyond its State borders. Large countries protect their products that can generate profit on the domestic market as well, in the form of customs. Closed economy is expensive for Montenegro. Free trade creates at the same time large opportunities for the

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economic growth, by encouraging investments, innovations and know-how transfer. As the most recent events on the world economic scene have shown, small economies, small and medium-size enterprises, through openness, flexibility and vitality, have succeeded to adapt faster to changes than large systems.

Scenarios. Due to the fact that because of the economic crisis Montenegrin economy will be exposed, within the following midterm, to significant risks, this year Economic and Fiscal Programme is also based on the development of two macroeconomic and fiscal scenarios for the period from 2010 to 2012. The development of such scenarios, in the conceptual sense, is the continuation of the work initiated in the former Economic and Fiscal Programme, which proved to be very useful instrument for managing the economic policy at the time of the crisis. This year scenarios take as a basis the risks that Montenegro was exposed to in 2009 (they were identified and articulated in the former Economic and Fiscal Programme). A special focus is placed on the projection of macroeconomic indicators regarding the year of 2010, bearing in mind that the period from 2011 to 2012 is extremely uncertain. The basic difference between the two scenarios is whether and to which extent macroeconomic and financial risks from 2009 would be continued in 2010. The basis for creation of the scenarios is not any more the elaboration of risks that the Montenegrin economy is exposed to, but the analysis of its resistance or non-resistance in case of further deepening of the crisis in 2010. Thus, the first scenario called “base scenario” that the State budget for 2010 is based on envisages a slight recovery of the economy in 2010 – a real GDP growth of 0.5%, with the reduction of illiquidity of the private sector and slight increase of the credit activity. The second scenario called “crisis scenario” is based on further deepening of the crisis in 2010, a real retraction of GDP of 2%, with further stagnation of external demand, stagnation of export due to the loss of the market, lower inflow of FDI due to further decline in real estate prices, failure to realize the privatization plan for 2010, as well as on stagnation of new investment projects, and ongoing illiquidity of the private sector that drastically reduces the level of investments in gross fixed capital. This scenario is developed for the purpose of determining “resistance point” of the Montenegrin economy in case of deepening of the financial crisis in the following period. It is especially necessary to emphasize that the realization of this “crisis scenario” would occur only under the conditions of the simultaneous occurrence of all aforementioned negative trends, which is unlikely to happen. However, if some of the negative trends do occur, real performances of the economy would be somewhere between the “base scenario” and the “crisis scenario”.

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2. ECONOMIC FRAMEWORK

2.1. Analysis of the macroeconomic trends in Montenegro in 2008 and within the period from January to September 2009

It is necessary to divide macroeconomic trends in Montenegro in 2008 and within the first nine months of 2009 into two periods. The first period includes the first three quarters of 2008, i.e. the months of still relatively good economic performances. The second period includes the trends from the last quarter of 2008 to the end of the third quarter of 2009, i.e. the period when the global financial and economic crisis has fully spread to the economy of Montenegro. Statistical data in Table 1 clearly show those two periods. For example:

In 2008, Montenegro still had a real economic growth of even 6.9%. Within the period from January to September 2009, a downturn in economic growth was estimated to 4.0%, and the activities’ downturn happened in almost all sectors.

In 2008, an annual inflation rate, measured by consumer price index, was 6.9% which was at least partially caused by extremely strong economic activity. Inflation reduced to only 1.7% by September 2009.

In 2008, a growth rate of import of goods and services was even 21.9% (rate of export of goods and services was only 4.6%). Within the first nine months of 2009, the import was drastically reduced – by even 36.5% (export of goods and services dropped by 18.9%). As a consequence of such trends, a negative balance of the current account of the balance of payment declined from 35.2% of GDP in 2008 to 24.8% within the period from January to September of 2009.

In spite of the crisis, the country demonstrated some very favourable trends. One of such areas is the growth of employment in the formal sector, i.e. the reduction of the unemployment rate. So, contrary to majority of other countries, Montenegro in 2009 recorded both growth of formal employment of 5.5% and reduction of unemployment (from 10.7% in 2008 to 10.3% in September 2009). On the other hand, the data of the survey about labour force show the reduction of number of employees, which implies that the loss of jobs due to the crisis was in the sector of grey economy.

Furthermore, net foreign direct investments (FDI) in 2008 were 567.6 million euro, and within the period from January to September 2009, they were even 764.7 million euro. A significant growth of FDI was largely the result of successful sale and recapitalization of Electrical Company of Montenegro. Inflow on such a basis was 420 million euro, out of which the State generated on the basis of the sale of shares around 100 million euro, which is also the amount generated by EPCG on the basis of the recapitalization.

TABLE 1: Montenegro: Main economic indicators, 2007-20092007 2008 I - IX 2009

GDP – real growth, % 10.7 6.9 -4.0Inflation, %11 8.0 6.9 1.4Employment growth (persons), % 6.1 6.3 5.5Unemployment rate, % 11.9 10.7 10.3Export of goods and services, current prices, in million euro

1,217.5 1,273.4 818.2

1 The year of 2007 inclusive, retail price index was used as inflation indicator, whereas consumer price index has been used from January 2008.

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Growth rates of export of goods and services, % 14.2 4.6 -18.9Import of goods and services, current prices in million euro

1,936.7 2,359.9 1,425.5

Growth rates of import of goods and services, % 12.7 21.9 -36.5Balance of trade in goods and services, current prices in million euro

-719.2 -1,086.5 -607.3

Balance of trade in goods and services, % GDP -26.8 -35.2 -24.6Balance of current account, current prices in million euro -642.8 -1,005.7 -332.1Balance of current account, % of GDP -24.0 -32.6 -13.5Gross capital formation, in current prices, in million euro 867.1 1,180.2 -Gross capital formation, % of GDP 32.3 38.3 -Foreign debt in million euro 462.1 481.7 645.2Foreign debt, % of GDP 17.2 15.6 21.022

Net foreign direct investments, current prices, in million euro

524.9 567.6 764.7

Net foreign direct investments, % of GDP 19.6 18.4 31.0Source: Central Bank of Montenegro (CBCG), Ministry of Finance, MonstatSource: Central Bank of Montenegro (CBCG), Ministry of Finance, Monstat

2.1.1. Gross Domestic Product

Real growth of GDP in 2008 was 6.9%. Together with a high level of FDI, this growth was dominantly caused by the growth of: service activities with the increase in tourism turnover, traffic turnover, trade and construction works turnover. The first nine months of 2009 brought on a GDP real retraction of approximately 4.0% compared to the same period last year. This retraction is the consequence of the effects of the economic and financial crisis on the general economic activity downturn, mostly in industry, construction, traffic and trade. Even higher retraction of GDP was prevented by: tourism turnover that was at the level of the previous year, increase in agricultural production and higher net inflow of FDI.

Industrial production: Global slowing down of the economic growth affected also the dynamics of the industrial production in Montenegro. The production of base metals and the generation of electrical energy had the crucial impact on its trend. In 2008, industrial production was lower by 2.0% compared to the previous year. Two sectors, the sector of generation of electrical energy, gas and water, and the sector of mining and quarrying, generated the growth of 31.9% and 17.7% respectively, whereas the sector of downstream industry recorded a drop of 11.3%.

Within the period from January to September 2009, the physical volume of industrial production was lower by 30.9% compared to the comparative period of the last year. The production in the sector of downstream industry was lower by 36.6%, in the sector of mining and quarrying it was lower by 64.5%, and in the sector of generation of electrical energy, gas and water, due to the repair of power plant Pljevlja, it was lower by 1.9%.

In Montenegrin industry, the production of base metals is dominant (in 2008, it was 41.3% of the total industrial production, and 59.7% of the downstream industry), i.e. the production of two large systems (Aluminium Plant -KAP and Steel Plant-Zeljezara). In 2008, the production of base metals, strongly affected by the economic crisis, and the decrease in demand and drop in sale prices of aluminium and steel below their production prices, was lower by 11.3%, and within the first nine months of 2009 compared to the same period in 2008 it was reduced by 50.0%. If the production of the base metals in 2009 had been at the level of the previous year, the total industrial production in 2009 would have been lower by

2 Foreign debt on 30 September 2009 in relation to the estimated GDP for 2009 Foreign debt on 30 September 2009 in relation to the estimated GDP for 2009

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10%, and the production in downstream industry would have been lower by 6.5% compared to the previous year. It shows that KAP and Zeljezara, as the largest industrial producers, almost fully dictate the level and index of the realized industrial production.

Tourism: Upward trend continued in 2008 in tourism sector, as well as the increase in the number of arrivals and overnight stays of tourists and generated revenues. In 2008, 6.4% more tourists more visited Montenegro and there were 10.3% of overnight stays more than in the last year. Growth of the number of foreign tourists (3.6%) is important, as well as their overnight stays (7.2%). A positive characteristic of the structure of foreign tourists is reflected through an increasing share of tourists from the European Union countries (21%), together with still significant share of tourists coming from Russia (12%) and Serbia (37%).

A dominant position in tourism is held by the coastal region that records 95.7% out of the total number of overnight stays (Monstat, Monthly Statistical Review, 1/2009). In accordance with the data of the World Travel and Tourism Council, it is estimated that in 2008, approximately 26.4% of the Montenegrin GDP was generated by the sector of tourism 33, and that 37,000 of employees were engaged or 1.8% more than at the same period of the last year. Total revenues were around 15% higher than in the previous year, amounting to 552 million euro (WTTC – Montenegro Travel and Tourism).

Tourism turnover within the period from January to September 2009 is approximately at the level of the previous year. Proceeds from tourism amounted to around 480 million euro, which is around 2.0% more than at the same period of 2008; there were 7,297,155 overnight stays, which is by 2.0% less than last year; 1,145,027 arrivals were registered, which is by 2.4% more than at the same period last year. The number of domestic overnight stays is higher by 3.8%, whereas the number of foreign overnight stays is less by 2.7%. The number of domestic visitors is higher by 5.1%, whereas the number of foreign visitors is higher by 2.0%.

Construction: A favourable environment for the performance of the economic activity in 2008, with high aggregate demand, and within that framework, high scope of new investments, generated a growth of construction activity. Value of executed construction works in 2008 was 412.4 million euro, and it was higher by 44.5% than in 2007. The largest part of the executed construction works (65.1%) relates to buildings, out of which 68.3% relates to residential buildings. The value of executed construction works regarding traffic infrastructure was 28.1% of the total works. Activity in construction, measured by executed effective working hours, shows the increase of 20.7% in 2008.

In 2009, the impact of economic and financial crisis on making illiquidity problem more severe, and the problems in maintaining credit activities of banks and difficulties in servicing credit obligations by clients, strongly influenced the possibility to provide funds for investments, primarily for completing already initiated works in the area of apartment constructions. The total executed construction works within the period from January to September 2009 were in the amount of 159.6 million euro and they were lower by 23.6% compared to the comparative period. The value of executed construction works on buildings (52.1% of the total executed construction works) in this period was lower by 22.7%. Effective working hours in construction area were lower by 17.8%.

Foreign trade in goods – Foreign trade in goods – The global economic crisis, through the drop in world prices ofThe global economic crisis, through the drop in world prices of primary products and fall in world demand, has especially had negative impact on trends ofprimary products and fall in world demand, has especially had negative impact on trends of foreign trade in goods. Total foreign trade in goods for nine months of 2009 was lower byforeign trade in goods. Total foreign trade in goods for nine months of 2009 was lower by

3 Multiplicative effect generated by the area of tourism.Multiplicative effect generated by the area of tourism.

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39.2% compared to the same period last year. Export for nine months was reduced by39.2% compared to the same period last year. Export for nine months was reduced by 39.3%, whereas import for nine months was reduced by 39.1%. 39.3%, whereas import for nine months was reduced by 39.1%.

In accordance with the data from Monstat, and based on special trade regime, MontenegroIn accordance with the data from Monstat, and based on special trade regime, Montenegro realized from January to September of 2009 the total foreign trade in goods in the amount ofrealized from January to September of 2009 the total foreign trade in goods in the amount of 1,413.31 million euro, out of which the export was 208.28 million euro, whereas the import1,413.31 million euro, out of which the export was 208.28 million euro, whereas the import was 1,205.03 million euro. was 1,205.03 million euro.

Decline in export of approximately 135 million euro was mostly the consequence of theDecline in export of approximately 135 million euro was mostly the consequence of the decline of export of products of iron, steel and aluminium. This indicator has recently showndecline of export of products of iron, steel and aluminium. This indicator has recently shown a lower degree of correlation with the changes in GDP due to the change of revenuea lower degree of correlation with the changes in GDP due to the change of revenue structure. structure.

Foreign trade in services – Foreign trade in services – The total volume of foreign trade in services within the periodThe total volume of foreign trade in services within the period from January to September 2009 was 830.4 million euro, and it was lower than in thefrom January to September 2009 was 830.4 million euro, and it was lower than in the comparative period by 10.8%. At the same time, the export of services was reduced by 8.3%comparative period by 10.8%. At the same time, the export of services was reduced by 8.3% and it amounted to 609.9 million euro, and the import of services was reduced by 17.1%,and it amounted to 609.9 million euro, and the import of services was reduced by 17.1%, and it amounted to 220.5 million euro. and it amounted to 220.5 million euro.

2.1.2. Inflation

Measured by the consumer price index, inflation in December 2008 compared to December 2007 was 6.9%, whereas the average rate for the period from January to December 2008 compared to the same period in 2007 was 7.4%. In 2009, inflation significantly reduced. As shown in Table 2, in September 2009, inflation was 1.4% compared to December 2008. At the annual level it was higher by 1.7%, whereas the average inflation rate for the period from January to September 2009 compared to the same period of the previous year was 3.9%. Under the conditions of the reduced aggregate demand and economic activity downturn, the reduction of inflation has been in accordance with the expectations. Under the conditions of the reduced external impact on prices, possible changes relate to the trends of the oil and oil derivatives market and electrical energy market.

TABLE 2: Trends of consumer price indexesTABLE 2: Trends of consumer price indexesStructureStructure %%

09.200909.200912. 200812. 2008

09.200909.200909.200809.2008

01-09.200901-09.200901-09.200801-09.2008

Consumer price index - totalConsumer price index - total 100.0100.0 101.4101.4 101.7101.7 103.9103.9Food and non-alcoholic beveragesFood and non-alcoholic beverages 42.542.5 100.1100.1 101.6101.6 104.2104.2Alcoholic beverages and tobaccoAlcoholic beverages and tobacco 4.84.8 107.6107.6 107..8107..8 107.1107.1Clothing and footwearClothing and footwear 8.28.2 99.299.2 99.799.7 101.0101.0HousingHousing 12.812.8 100.0100.0 107.8107.8 117.5117.5Home furnishings and homeHome furnishings and home equipment equipment

5.45.4 94.094.0 94.194.1 98.598.5

HealthHealth 2.32.3 100.9100.9 102.2102.2 103.3103.3TransportationTransportation 10.010.0 110.9110.9 96.096.0 92.892.8CommunicationsCommunications 6.66.6 105.2105.2 105.1105.1 103.2103.2Culture and recreationCulture and recreation 2.92.9 99.699.6 99.199.1 100.9100.9EducationEducation 0.20.2 100.0100.0 100.0100.0 100.0100.0Restaurants and hotelsRestaurants and hotels 0.10.1 115.9115.9 115.9115.9 106.8106.8Other goods and services Other goods and services 4.34.3 101.1101.1 101.2101.2 101.3101.3

SourceSource: Monstat: Monstat

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2.1.3. Labour market

The economic crisis has made the possibilities to keep the existing level of employment, especially in larger systems, worse. In accordance with the data obtained from MONSTAT, the average number of employees in the formal sector in the first ten months of 2009 increased by 5.4% compared to the same period of 2008 (from 165,641 to 174,523). August of 2009 recorded the maximum number of employees (179,016 employees), after which the employment reduced in September by 1.1% compared to August, and in October by 0.6% compared to September. Constant increase of formal employment within the first eight months, in spite of economic activities’ downturn, is a result of several factors, out of which the most important measures of the Government are the measures for mitigating the consequences of the global economic crisis, creating more favourable fiscal envelope and reducing tax burden, which led to the transfer of labour force from informal to formal sector. The reduction of employment recorded in September and October shows that, since the period of strong economic growth was interrupted by the crisis, employment in the formal sector will probably have a long-term upward trend in the second and third quarter thanks to the summer season, whereas the first and the fourth quarter are characterized by somewhat lower employment.

The impact of the economic crisis on the labour market is probably reflected through informal market. In accordance with the labour force survey, the total number of employees in the first three quarters of 2009 compared to 2008 was lower. Also, the survey records the reduction of the number of unemployed persons that influenced the reduction of the activity of the labour force by 0,7percentage points in the first quarter of 2009 compared to the fourth quarter of 2008. The third quarter, thanks to the summer season, gave better results, since there was reduction of unemployment, increase of employment, as well as of the labour force activity by 0.6 percentage points.  The number of unemployed persons in the records of the Employment Office, until the end of September 2009, reduced. At the end of September 2009, there were 27,269 unemployed persons recorded, which is by 3.3% less compared to the same month of the last year, and by 1.8% more compared to August 2009. In accordance with the aforementioned, the unemployment rate reduced from 11.2% in September 2008 to 10.3% in September 2009, which indicates that the measures taken by the Government of Montenegro for the purpose of mitigating the consequences of the crisis have given the results. However, at the end of October 2009, the number of unemployed persons was increased to 28,855, and the28,855, and the unemployment rate to 10.7%. Bearing in mind that employment as economic activityunemployment rate to 10.7%. Bearing in mind that employment as economic activity indicator by rule comes later than other economic activity indicators, and that within the lastindicator by rule comes later than other economic activity indicators, and that within the last few months it has shown a downward tendency, it is expected in the following year to havefew months it has shown a downward tendency, it is expected in the following year to have an increase of unemployment, which would have a negative impact on aggregate demandan increase of unemployment, which would have a negative impact on aggregate demand and increase of default credit repayments in the banking sector. and increase of default credit repayments in the banking sector.

2.1.4. Banking sector

Trends in 2008: Assets of the banking sector in Montenegro in 2008 increased per average monthly rate of 1% reaching the amount of 3.3 billion euro at the end of the year. The crisis is the main reason for reduction of the total deposits in the banking sector by 4.8% in 2008, and the fall of households deposits was even 16.0%. At the end of 2008, households deposits were 856.5 million euro.

Measures taken by the Central Bank of Montenegro for the purpose of reducing credit growth and reducing pressures on consumption and inflation have proved to be efficient, and the total credits in 2008 increased by only 24.6%, which is significantly less than in 2007 when they were increased over 2.5 times – out of which, loans to the households sector

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were increased by 30.7%, and to the corporate sector 21.4%. However, in the last quarter of 2008, the global financial crisis had a significant impact on interrupting the credit expansion. The crisis has affected active interest rates in Montenegro. Over 2008, they got slightly increased, and in December they were by 0.11 percentage points higher than a year before.

Table 3: Selected banking sector indicators, 2005 – 2008 (in 000 000 euro; %)

Description/Period 2005 2006 2007 2008 Change2008-2007

20082007

Assets of banks 695.8 1,431.4 2,975.4 3,309.7 334.3 11.2Total credits 375.9 847.2 2,245.7 2,797.5 551.8 24.6 Corporate credits 230.1 471.3 1,364.4 1,657.0 292.6 21.4 Households credits 104.3 311.2 794.1 1,037.6 243.5 30.7Total deposits 487.9 1,075.8 2,091.1 1,990.6 -100.5 -4.8 Corporate deposits 143.9 321.0 663.5 589.5 -74.0 -11.2 Households deposits 175.7 499.4 1,019.4 856.5 -162.9 -16.0Allocated mandatory reserve requirements 61.7 172.8 259 216.6 -42.4 -16.4

Due to the effects of the financial crisis, the banking system at the end of 2008 was characterized by the decline in the basic liquidity indicators compared to the end of 2007. Available funds for payments have been reduced, the credit/deposit ratio deteriorated, the share of liquid assets in the total assets reduced, the share of non-performing credits in total credits increased. Over the first nine months of 2008, the banks regularly fulfilled their current obligations, whereas in the fourth quarter, influenced by the global financial crisis that affected the Montenegrin economy, one bank had pronounced problems to maintain liquidity.

The total assets of the banks available for payments were from 333.4 to 532.9 million euro. As it can be seen from Table 4, in 2008 these funds were on the average 438.6 million euro, which was significantly below the average in the last year. Considered by months, the highest level of average available funds for payment was recorded in April (485.9 million euro), and the lowest in November (375.0 million euro). The payments made to the banks were constantly lower than available funds for the payment and they were on the average 45 million euro. On the basis of the trends of available funds and made payments, a surplus was created in the average amount of 392.9 million euro. Average payments made/average available funds for payments coefficient in 2008 was 0.104 and it is similar to the one in the previous year, which was 0.099.

Table 4: Average of available liquid funds and payments made by banks, 2005 – 2008 (in 000 euro)

Description/Period 2005 2006 2007 2008Available liquid bank funds 137,166 267,724 472,216 438,619Payments made 17,935 27,337 46,708 45,737Surplus 119,231 240,387 425,508 392,882

At the end of 2008, liquid assets of the banks4 were 370.7 million euro and compared to the end of 2007, they were reduced by 31%. The share of liquid assets in the total assets was 11.2%, and it was reduced compared to the end of 2007, when it was 18.06%. Credit/deposit coefficient was 1.41 at the end of the year, which was a deterioration compared to the end of 2007 when it was 1.08. Within the first three quarters of 2008, mandatory reserve for liquidity was not used, whereas in the last quarter two banks used mandatory reserve funds for liquidity.

4Monetary funds and deposits with depositary institutions.

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Trends in 2009: The first eight months of 2009 clearly show the extent to which the financial and economic crisis affected the Montenegrin banking sector. Table 5 shows that this period is characterized by the reduction of bank assets and deposits, and by the reduction of credit activities of banks.

At the end of August 2009, the assets of banks were 3,064.2 million euro; reduction of banks’ assets compared to the end of 2008 was 7.4%, and the annual reduction was 12.5%. The total deposits deposited with banks were 1,730.4 million euro at the end of August 2009 and they are reduced by 13.1% compared to the end of the previous year, and by 26.2% compared to the same month of the previous year. During the first eight months, the total deposits were reduced on the average on monthly basis by 1.7%, and a positive growth rate was recorded only in May (2%).

Researches of the Central Bank show that an important reason for reduction of deposits is that banks, in case clients failed to repay credits, were using deposits as cash collateral in order to satisfy their claims. It should be noted that in the first eight months of 2009, reduction of deposits slowed down compared to the fourth quarter of the last year, when deposits fell on the average monthly basis by 5%. In addition to other things, the sale of shares of EPCG and its recapitalization influenced the slowdown of reduction of deposits within the observed period and growth of deposits in May.

Households deposits were 767.1 million euro at the end of August 2009 and compared to the end of the previous year, they were reduced by 10.6%. During the first five months, they dropped on the average monthly basis by 2.7%, whereas within the period from June to August, they increased on the average monthly basis by 0.9%.

At the end of August 2009, the total credits were 2,572.9 million euro and they were by 8.0% lower than at the end of the previous year, whereas the annual fall was 9%. During the first eight months of 2009, credits of banks recorded the average monthly fall of 1.0%, whereas during the first eight months of the previous year, the credits increased on the average monthly basis by 2.9%. Observed by banks, at the end of August of this year and compared to December 2008, six banks recorded the growth of credits, whereas the other five recorded a fall.

Table 5: Selected banking sector indicators in 2009

Description/Period VIII 2009XII 2008

VIII 2009VIII 2008

Bank assets -7.4% -12.5%Total credits -8.0% -9.0%

Corporate credits -9.5% -10.9%Households credits -7.8% -7.3%

Total deposits -13.1% -26.2%Corporate deposits -19.5% -33.4%Households deposits -10.4% -31.7%

Allocated mandatory reserve -26.9% -47.0%

Decision on minimum standards for managing liquidity risk5, which is being applied from January 2009, prescribes the obligations of banks to maintain minimum liquidity coefficients6

on a daily (0.9%) and decade basis (1.0%). As shown by Table 6, within the period from January to August 2009, liquidity coefficient on a daily and decade basis was above the prescribed minimum for the entire banking sector. However, observed by banks, during the

5 Decision on minimum standards for managing liquidity risk in banks (Official Gazette of Montenegro, No 60/08). Reporting based on this Decision is applicable from 1 January 2009.6 Ratio of liquid assets of banks and due obligations for credits and loans.

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first eight months of this year, one bank constantly had lower daily and decade coefficients than the prescribed ones. The structure of liquid funds of banks at the end of August 2009 shows that 57.3% of total liquid assets of banks relate to liquid funds in the country, whereas 42.7% relate to funds of banks abroad.

Table 6: Aggregate liquidity indicator of banks in 2009

Description/ Period 31 Jan 28 Feb 31 Mar 30 Apr 31 May 30 Jun 31 Jul 31 AugI. Liquid funds of banks 270,596 255,177 284,767 277,993 315,916 326,402 380,567 382,210II. Due obligations for credits and loans 201,254 192,118 231,507 223,617 224,260 229,545 242,772 245,703III. Liquidity indicators ( I : II ) 1.34 1.33 1.23 1.24 1.41 1.42 1.57 1.56

Source: Daily reports of banks

Liquid assets of banks7, at the end of August of this year, were 370 million euro, and they were increased compared to the end of the previous year by 4.7 million euro or 1.3%, whereas compared to the same month of the previous year they were reduced by 20.6%. At the end of August 2009, the share of liquid assets in the total assets was 12.06% and it was increased compared to the end of 2008 (11.03%), and reduced compared to August of the previous year (13.3%).

Economic policy measures directed to strengthening of the banking sector stability under the conditions of the crisis: For the banking sector and the Central Bank of Montenegro, as the regulator, the years of 2008 and 2009 were the years of big challenges. While until the fall 2008, under the conditions of extremely rapid economic growth characterized also by the elements of overheating, the Central Bank tried to prevent too extensive credit activity of the banks, in the period after the emergence of the crisis, i.e. just before the end of 2008, its activity was concentrated on providing stability to the banking sector that was strongly affected by the crisis.

Thus, in 2008, a set of regulations was adopted that regulates in greater details the banking operations. The goal of the Law on Banks and a set of secondary regulations that are stricter than the international accounting standards was to prepare the banking sector as good as possible for the possible negative consequences of the global financial crisis. In addition to the aforementioned, in 2008, the decision of the Central Bank was in force that limited credit expansion, so that banks, especially in the second half of that year, were faced with pronounced demand for credits and large restrictions to satisfy that demand.

Furthermore, in order to create protection against the consequences of the global financial crisis and preserve its security and stability, at the proposal of the Government and the Central Bank, the Parliament adopted the Law on Measures for the Banking System Protection. In accordance with this Law, the Central Bank of Montenegro adopted the Decision on Using the Bank Mandatory Reserve Requirement Held with the Central Bank for a Period Longer than One Day and the Decision on Granting Short-Term Loans to Banks.

Intensive harmonization of the legal framework for operations of banks under the crisis was continued in 2009. During the first quarter of that year, the regulations were amended regarding the mandatory reserve instrument and using a part of allocated mandatory reserve, in order to support the liquidity of banks. Also, the decision is adopted regarding the establishment of banking ombudsman that provides for better protection of banks’ clients. In 7 Liquid assets, in accordance with the new Decision on managing liquidity risk, consist of monetary assets and deposits with depositary institutions reduced by 50% of allocated mandatory reserve, and the sources of data are monthly reports of banks.

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June 2009, the Decision on Amendments to the Decision on Minimum Standards for Credit Risk Management in Banks is adopted, as well as Decision on Amendments to the Decision on Bank Capital Adequacy, Decision on Amendments to the Decision on Minimum Standards for Risk Management in International Financial Institutions, Decision on Amendments to the Decision on Bank Mandatory Reserve Requirement to be Held with the Central Bank of Montenegro, and the Decision on Amendments to the Decision on Using Bank Mandatory Reserve Requirement Held with the Central Bank of Montenegro for the Period Longer than One Day. The goal of adopting these decisions is to stop, i.e. mitigate the reduction of quality assets, to improve the credit activity and to stimulate banks to undertake more intensive activities to attract new and recover previously withdrawn deposits. In August 2009, the Central Bank Council adopted a set of temporary measures that enable more favourable conditions for credit restructuring, asset classification and lower calculation of provisions for credit losses. The goal of adopted measures is to improve the position of banks and their debtors, as well as to preserve stability and security of the banking system.

At the end of December, the Central Bank amended the Decision on Temporary Measures for Credit Risk Management that envisages certain reliefs for banks with the goal to initiate the credit activity. The new measures reduced provisions for certain classification groups. Also, it is envisaged that the banks when estimating creditworthiness of debtor may exclude operating indicators for 2009. In addition to the aforementioned, banks are enabled to classify credits approved for investments in development projects by analysis of project profitability, and not by assessing creditworthiness of the debtor. A change is also that reliefs for credit restructuring may be applied to credits whose repayment is late up to 180 days (instead of 90 days that used to apply).

2.1.5. Balance of payments

Montenegro started to feel the impact of the global crisis, which has begun in the summer 2007, a year after in the area of foreign economic relations. Table 7 contains the main data on the current balance of payments account of Montenegro within the period from 2006 to September 2009. Further below trends of the current and capital part of the balance of payments of the country will be presented in greater details, especially for 2008 and 2009.

Table 7: Current account of Montenegro from 2006 to September 2009, in thousand euro

 

2006 2007 2008Jan. – Sep. 2009

Index

2007/2006 2008/2007Jan –Sep 2009/Jan –Sep 2008

A. CURRENT ACCOUNT(1+2+3+4) -531,207 -642,786 -1,005,664 -332,144 121.00 156.45 46.24 1. GOODS -849,325 -1,159,322 -1,489,603 -736,838 136.50 128.49 62.61 1.1. Revenues 648,327 543,411 519,088 242,197 83.82 95.52 59.01

1.2. Expenditures1,497,65

1 1,702,733 2,008,691 979,035 113.69 117.97 61.68 2. SERVICES 197,099 440,133 403,082 389,370 223.31 91.58 97.55 2.1. Revenues 418,036 674,056 754,278 609,906 161.24 111.90 91.69 2.2. Expenditures 220,937 233,923 351,196 220,536 105.88 150.13 82.90 3. INCOME 30,800 17,010 7,785 -44,405 55.23 45.77 3.1. Revenues 65,334 89,420 128,356 87,029 136.87 143.54 92.43 3.2. Expenditures 34,534 72,410 120,570 131,434 209.68 166.51 150.88 4. CURRENT TRANSFERS 90,220 59,394 73,072 59,729 65.83 123.03 113.96 4.1. Transfers to 108,555 100,775 109,321 83,867 92.83 108.48 104.56

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Montenegro 4.2. Transfers from Montenegro 18,336 41,381 36,248 24,139 225.69 87.60 86.83

Source: CBCG

Balance of payment trends in 2008: Considered at the annual level, the year of 2008 is characterized by the increase in deficit of the current account, record income of tourism, further growth of expenditures based on services, record net FDI, as well as inflow of funds in the form of other investments and reduction of reserves. Deficit of the current account of balance of payments in that year was 1,005.7 million euro, which is by 56.5% more than in 2007. Deficit of the current account was significantly increased, as well as its share in GDP. Whereas in 2007, it was 24.0%, in 2008 it increased to 32.6% of GDP. Considered by quarters, it is obvious that as a result of slowing down of the economic activity, in the fourth quarter of 2008, there was the reduction of current account deficit by 7.4% compared to the same period of the previous year. This primarily happened due to the reduction of import, i.e. reduction of the possibility to finance the import (the basic generator of the current account deficit), and because of significant reduction of foreign indebtedness of companies and reduction of reserves.

Results of foreign trade in goods of Montenegro are still worrying, since the trade structure is still relatively unfavourable and the level of export diversification is low. Lack of diversification of export and its orientation primarily to the European Union market, which is affected by the crisis, as well as changes in aluminium prices on the world exchanges led to the reduction of export of goods in 2008. The international trade in goods in 2008 recorded the reduction of export and the growth of import of goods. Deficit on goods account was 1,489.6 million euro, which is by 28.5% more compared to 2007. The share of foreign trade deficit in GDP was 48.3%.

As far as international trade in services is concerned, in 2008 Montenegro realized surplus in the amount of 403.1 million euro, which is by 8.4% less compared to 2007, and it is the consequence of faster growth of expenditures than of revenues. The total volume of trade in services in 2008 was 1,105.5 million euro, which is by 21.8% more compared to 2007. Export of services shows a tendency of continuing growth over the past few years. Revenues from services in 2008 were 754.3 million euro, and they were higher by 11.9% compared to the previous year. The highest revenues were realized on the basis of travelling in the amount of 515.2 million euro, then transport in the amount of 92 million euro, construction services in the amount of 54.3 million euro, and other business services in the amount of 40 million euro. Expenditures from services were 351.2 million euro, which represents the increase of 50% compared to 2007. The increase in expenditures from services is the consequence of the increase in expenditures in the area of other business services, transportation services, construction and personal services, cultural and recreational service. In the structure of expenditures, expenditures realized on the basis of other business services have the largest share in the amount of 92.8 million euro, which represents an increase of 60.6%, and it is the consequence of the increase in expenditures based on various business services.

Surplus was realized on the factor income account in the amount of 7.8 million euro, and surplus on the current transfers account was 73.1 million euro.

On the capital financial account in 2008, a significant inflow of foreign capital was recorded, and the record net inflow of FDI was realized in the amount of 18.4% of GDP. Exceptionally high inflow of FDI is even more important bearing in mind the situation on the world markets and increase of risk and investment costs. Net inflow of FDI (inflow minus outflow) was 567.6 million euro, which is by 8.1% more compared to 2007. The total inflow of FDI within the given period was 832 million euro or 17.4% less compared to the previous year, out of which

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824.9 million euro related to the investments of non-residents in Montenegro, and 7.2 million euro to withdrawing of funds invested abroad. On the account of portfolio investments in 2008, the inflow of 182.9 million euro was recorded, whereas the outflow of funds was 198.4 million euro. On the account of other investments, net inflow in the amount of 337.4 million euro was realized, which is by 10.2% less than in 2007.

Balance of payments trends in 2009: Reduction of domestic and external demand had an impact on foreign economic relations of Montenegro in 2009. Balance of payments trends for the first nine months of 2009 were characterized by the reduction of current account deficit, reduction of foreign trade deficit, surplus on the account of services and transfers, record high inflow of FDI and reduction of indebtedness of companies and banks abroad.

Based on preliminary data shown in Table 7, deficit of the current account of the balance of payments from January to September 2009 was 332 million euro, which is by 53.8% less compared to the same period of 2008. Considered in percentages of GDP, current account deficit was 12.4%.

The total volume of trade in goods from January to September 2009 was 1221.2 million euro and it was reduced by 38.9%, whereas the foreign trade deficit was 736.8 million euro and it was by 37.4% less than in the same period of 2008. Offsetting the foreign trade deficit by surplus realized on other accounts of the current account was 54.9%, which is by 16 percentage points greater than in the same period of 2008. Import was offset by the export of goods in the amount of 24.7%.

As far as international trade of services of Montenegro is concerned, in the first three quarters of 2009, Montenegro realized surplus in the amount of 389.4 million euro, which is by 2.5% less than in the same period of 2008. The total volume of trade in services was 830.4 million euro and it is by 10.8% less compared to the same period of the last year. Revenues from services were 609.9 million euro and they are lower by 8.3% compared to the same period last year. The highest revenues were realized on the basis of travelling – tourism in the amount of 459.3 million euro, then transport in the amount of 75.9 million euro, construction services in the amount of 21.1 million euro, and other business services in the amount of 21 million euro. Expenditures from the services were 220.5 million euro, which represents the reduction by 17.1%. In the structure of expenditures, expenditures on the basis of transport have the largest share in the amount of 52.6 million euro, other business services in the amount of 50.5 million euro, where the most substantial expenditures are expenditures based on various business services.

On the factor income account, deficit is realized in the amount of 44.4 million euro, whereas surplus is recorded on the account of current transfers in the amount of 59.7 million euro.

The capital and financial account trends within the first nine months of 2009 were characterized by record inflow of FDI and net outflow on the accounts of portfolio and other investments. In accordance with the preliminary data, net inflow of FDI (inflow minus outflow) within the first nine months of 2009 was 764.7 million euro, which is by 69.3% more compared to the same period of 2008. The total inflow of FDI within the given period was 857.5 million euro. Considered by months, the highest FDI inflow was recorded in September when the inflow was 314.9 million euro (see graph 1), and it is a result of the partial privatization and recapitalization of EPCG. As a consequence of revenues generated by partial privatization and recapitalization of EPCG, in 2009 the structure of FDI inflow was significantly changed compared to the previous years, when investments in real estate were dominant.

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Graph 1: Inflow of foreign direct investments, 2007 – 2009 per months (in 000 euro)

0

50.000

100.000

150.000

200.000

250.000

300.000

350.0002007 2008 2009

Source: Central Bank of Montenegro

On the account of portfolio investments within the first nine months of 2009, the record inflow of 33.4 million euro was recorded, whereas at the same time the outflow of funds was 66.5 million euro. On the account of other investments (which include credits, commercial credits, cash and deposits), the reduction of indebtedness of banks and companies and net outflow from the cash and deposits account were recorded. Inflow on the basis of credits taken abroad within the considered period was 167 million euro, which is significantly less than the inflow realized within the same period of 2008 (635 million euro). Limited and more expensive sources of financing in 2009 had the impact on reduction of indebtedness abroad.

2.2 Medium term Macroeconomic Scenario

Due to its high external exposure, as well as insufficient diversification and competitiveness of export during 2009, Montenegro, as a small country, was significantly affected by the world economic and financial crisis. Strength and dynamics of the impact of the crisis on the Montenegrin economy have changed on a monthly basis, so that uncertainty regarding projection of macroeconomic variables for the years to come is extremely high. Thus, for example, EBRD reviewed twice the data regarding macroeconomic projections of Montenegro for the following year; IMF reviewed them three times, while the development of the World Bank projections is underway.

Due to the fact that because of the economic crisis Montenegrin economy will be exposed, within the following midterm, to significant risks, this year Economic and Fiscal Programme is also based on the development of two macroeconomic and fiscal scenarios for the period from 2010 to 2012. The development of such scenarios, in the conceptual sense, is the continuation of the work initiated in the former Economic and Fiscal Programme, which proved to be very useful instrument for managing the economic policy at the time of the crisis. This year scenarios take as a basis the risks that Montenegro was exposed to in 2009 (they were identified and articulated in the former Economic and Fiscal Programme). A special focus is placed on the projection of macroeconomic indicators regarding the year of 2010, bearing in mind that the period from 2011 to 2012 is extremely uncertain.

The basic difference between the two scenarios is whether and to which extent macroeconomic and financial risks from 2009 would be continued in 2010. The basis of creation of the scenarios is not any more the elaboration of risks that the Montenegrin economy is exposed to, but the analysis of its resistance or non-resistance in case of further deepening of the crisis in 2010. Thus, the first scenario called “base scenario” that the State

21

budget for 2010 is based on envisages a slight recovery of the economy in 2010 – a real GDP growth of 0.5%, with the reduction of illiquidity of the private sector and slight increase of the credit activity.

The second scenario called “crisis scenario” is based on further deepening of the crisis in 2010, a real retraction of GDP of 2%, with further stagnation of external demand, stagnation of export due to the loss of the market, lower inflow of FDI due to further fall in real estate prices, failure to realize the privatization plan for 2010, as well as stagnation of new investment projects, and continued illiquidity of the private sector that drastically reduces the level of investments in gross fixed capital. This scenario is developed for the purpose of determining “resistance point” of the Montenegrin economy in case of deepening of the financial crisis in the following period. It is especially necessary to emphasize that the realization of this “crisis scenario” would occur only under the conditions of the simultaneous occurrence of all aforementioned negative trends, which is unlikely to happen. However, if some of the negative trends do occur, real performances of the economy would be somewhere between the “base scenario” and “crisis scenario”.

This Chapter below is devoted to the elaboration of both scenarios with a special emphasis on explaining the differences between them. The text is divided into two sections. The first section, Section 2.2.1, presents the so-called “risk map“. The last-year Economic and Fiscal Programme of Montenegro 2008-2011 articulates a set of risks associated with financial sector, real economy, fiscal sector, etc. The basic purpose of this section is twofold: i) to analyze a degree of taking place or non-taking place of such risks during 2009, and ii) evaluate extent to which it is possible to have such risks continued in 2010. The second section, Section 2.2.2, gives a breakdown of quantitative indicators regarding “the base scenario” and “the crisis scenario”, and it also gives a detailed review of trends of some macroeconomic aggregates that the development of scenarios is based on.

2.2.1. Map of Risks Relevant for the Montenegrin Economy 2010-2012

Outturn of main risks in 2009: Global economic crisis has marked extensively the economic development of Montenegro during 2009, especially having in mind that the Montenegrin economy had extremely high growth rates until the third quarter of 2008, estimated at even up to 10.7% in 2007 and 6.9% in 2008. However, the comparative advantage of Montenegro, dealing with the fact that the country is a “small and open economy”, became its comparative weakness in terms of generated high exposure to external shocks. In this manner, the global economic crisis has highlighted the poor diversification of the Montenegrin economy and exceptional comparative lack of competitiveness of some of its sectors, in particular in the segment of the industrial production.

Namely, as a result of the global crisis impact on the neighbouring countries, and consequently the reduction of the demand as well, primarily from the EU countries (as the most important export market of Montenegro), numerous Montenegrin companies were pushed out from the market. A consequence of that was a significant decline of export, which went back to the level from 2003, which in turn represented an indicative signal that in spite of efforts to affect the growth, the Montenegrin economy continues to have an unfavourable structure in its economic sector, in particular in respect of the production sector. On the other hand, in terms of the tourism sector, in spite of forecasts of the World Tourism Organisation concerning decline in the tourism revenues inflows during 2009, revenues of Montenegro generated in this year indicate that this sector is competitive as well as that there is a high level of its flexibility, meaning that relatively satisfactory results of the 2009 tourism season are reached primarily as a result of the change in strategy, focus being placed primarily on regional markets. The third segment of risk outturn, the impact of the global crisis on the national economy deals with the construction sector, where there was a

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significant activity fallback as a result of limited demand and pronounced indebtedness of this sector, which has altogether affected the drop in real estate prices of around 20.4% annually.

However, the impact of the global financial crisis on the Montenegrin economy affected the banking sector first and somewhat later public finances as well. Negative impact of the crisis on the Montenegrin banks became obvious from the 4th quarter of 2008, in order to escalate in the subsequent months, including the end of the first quarter of 2009. Consequences of the crisis were manifested through the significant reduction of the deposit potential of banks (around 25% if compared to the end of September 2008), somewhat difficult access of banks to external financing sources, reduction of inflows of funds from loan repayment caused by worsening of the financial standing of borrowers which led to the worsening of all asset quality parameters, as well as to the almost complete stoppage of the credit activity. As far as the public finances are concerned, key consequence of the crisis is the reduction in tax revenues because of sizeable slowdown of the economic activity, decline in import, lower demand and sale of real estate, and decreased inflow of foreign capital, along with an increase tax evasion as a result of reduced liquidity of the private sector.

Economic policy measures for the risk management in 2009: Similar to other countries, decision-makers reacted to the stated risks caused by financial crisis with economic policy measures, which could be generally divided into two groups. First group consists of the measures directed towards the stabilisation of the banking sector and the financial system in more general terms; and the second group of measures is focused on the fiscal adjustment to newly created conditions.

It is generally recognised that Montenegro, using euro as the legal tender, has very limited options in conducting the monetary policy. Those are primarily measures that contribute to the growth of liquidity of the banking system, first through manipulation of the use of mandatory reserves by banks, as well as by measures directed to the quicker consolidation of banks’ balances and strengthening of the base to continue with the credit activity. Specifically, during 2009 the CBM adopted set of measures: (i) single mandatory reserve rate is reduced from 11 to 10%; (ii) it was made possible for banks to hold 25% of the mandatory reserve in form of treasury bills issued by the state of Montenegro; (iii) period of using up to 50% of the funds allocated to the mandatory reserves is extended from seven to ten business days; (iv) annual interest rate for using the mandatory reserves was reduced from 5% to 4%; (v) annual interest rate on mandatory reserve funds not repaid by the bank in the same day was reduced from 9% to 7%; (vi) harmonization of the asset classification with the Basel Standards was undertaken in terms of the days in arrears, whereby the nonperforming assets represent assets in arrears for more than 90 days as compared to the applicable one which reads the nonperforming assets as the one in arrears for more than 60 days. Additionally, the classification of assets – losses has changed from present arrears of more than 180 days to an arrears period of more than 270 days; (vii) a new Decision on the Provisional Measures for Credit Risk Management in Banks was adopted, which enables banks to classify into a more favourable classification groups restructured loans starting from 1 January 2009, under the requirements defined by the Decision, provided that such assets will not affect the bank liquidity over the short- and long-term, which provides for duly debt servicing in future. Furthermore, this Decision has significantly relaxed the position of bank’s borrowers – legal entities and natural persons in arrears affected by the global crisis.

In terms of the public finances, the response of the economic policy to the substantial reduction of tax revenues was the revision of the 2009 Budget, having as a main feature the reduction of all main items of the budget spending, i.e. expenditures of the current budget, capital budget as well as budgets of the state funds, and there was also certain correction in respect of the revenue side of the Budget. Significant cuts were made with some items of the current budget, foremost the ones concerning gross wages of employees, costs of

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materials, services and rents, as well as the current maintenance. Transfers for social protection were increased at the same time as a result of increased number of users of such rights, whereby expenses for payments of technological redundancies in companies that were already privatised or are in the privatisation process were significantly increased. The reduction in capital expenditures took place for such items which are going to have a less of an impact on the future economic performance, such are the public administration buildings and similar.

2.2.2. “Base Scenario” vs. “Crisis Scenario”

Qualitative articulation of the “Base Scenario” and “Crisis Scenario”: As it was already mentioned, both scenarios are taking as a base risks that Montenegro was exposed to in 2009. The first column of the Table 8 lists the economic crisis risks for which, in the previous EFP, was expected that Montenegro will face in 2009. The second column states the assessment for each of those risks in terms whether such risk really took place in 2009 or not, with a brief explanation. Third and fourth column of the Table are intended for the exhibition of the “Base Scenario” and “Crisis Scenario” respectively, whereby in case of each individual risk that did not take place or took place in 2009 a possibility of such risk to continue or not in 2010 is assessed.

Table 8: Degree of risks taking/not taking place in 2009 and presentation of two scenarios for 2010

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Risks Risk taking or not taking place in 2009 Assessment of risk taking or not taking place in 2010“Base Scenario” “Crisis Scenario”

Stagnation or further drop in turnover in the real estate market

YesDrop in real estate prices in 2009 was 20.4%

NoReal estate prices are stagnating or having a mild growth of up to 5% annually

YesReal estate prices are dropping up to 5% annually

Further deepening of the crisis in countries – trade partners of Montenegro

YesBased on preliminary data, the most important import and export markets are having negative economic growth results accompanied with the sizeable drop in aggregate demand and private consumption

NoStagnation and mild recovery of the economic growth in EU and CEFTA countries in accordance with the IMF forecast (Regional Economic Outlook, October 2009) and EBRD forecast (World Economic Outlook, October 2009).

YesFurther decline of the economic activity in EU and CEFTA member countries

Further decline in industrial production

Yes Problems in operation of the largest producer in the processing industry – KAP, caused a drop in processing industry of 36.6%, while in the mining and quarrying sector the drop was 64.5%. Reason for such decline is mainly a consequence of the reduced production in the sub-sector of other mining and quarrying by 79.4%, whereby the ore mining reduction of 91.1% was the one with the highest contribution in terms of the production decline. Insignificant drop in electric power generation, gas and water of 1.9% is due to the reconstruction of production capacities.

No A recovery of aluminium prices in the global markets takes place, a problem with KAP is resolved and production is growing.

Yes No growth of aluminium and steel prices, and national companies being large exporters have a slow regain of markets lost in 2009. Late resolution of the excess employees’ problem in KAP, production starts only in the second half of 2010.

Stagnation in revenues from tourism

NoEven though the assumption was that 2009 would result in a significant decline in revenues from tourism, by focusing on local markets, price policy as well as extending of the season, have led to a growth of 2.3%, at least in terms of quantitative parameters, while the estimated revenues are somewhat lower than in 2008.

NoThe tourism sector indicates high level of competitiveness and resistance to global crisis, thus a growth from tourism would be up to 6% if compared to 2009.

Yes Stagnation is assumed and mild drop in revenues from tourism as a result of the assumption on further impact of the global crisis on the neighbouring countries.

Privatisation Plan not implemented

NoIn terms of its value, the Privatisation Plan in 2009 is implemented primarily through the privatisation of EPCG, thus the proceeds of so-called financing (privatisation revenues, borrowings and loans, and grants) are of 177.19 million euro in 2009.

NoThe assumption is that the privatisation process goes as planned, with an inflow of average 55 million euro annually during 2010-2012.

Yes The stagnation of privatisation-based investment’s inflows is assumed.

Further worsening of the liquidity of the economy

Yes Drop in the payment operations took place as early as mid 2008, much earlier than the economic activity downturn and GDP retraction, but such trend continued even during 2009 with gradual recovery during the last quarter of the year.

No

The assumption is that the growth of credit activity will affect the growth of payment operations.

PartiallyMild recovery of the payment operations, but which stagnates to the level from 2009 as a result of the economic activity slowdown.

Further reduction of credit supply

Yes Total approved loans from banks are being reduced at the rate of 9.86%, if compared to the comparative one-

NoStagnation of the credit activity continues with an estimated marginal credit growth of 1.2% annually.

Yes Reduction of credit activity, assumed marginal decline of

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year period, or at the rate of 2.25% if compared to the end of 2008. First negative rates in credit growth are registered in October 2008, when there was a suspension of credit activity of banks, as affected by the crisis, due to the problems with liquidity and more difficult access to the external sources of financing.

2% annually.

Possibility of further drop of deposit potential of banks

YesTotal deposit potential of banks as of 30 September 2009 was 1,900 million euro. As impacted by the global financial crisis, there was a significant outflow of deposits, thus an annual drop of 18.3% was recorded. If compared to the end of 2008 there is a growth in deposits of 7.19%.

NoThe assumption is that there will be a mild recovery of the deposit potential in the coming period, i.e. that the deposit growth trend since May 2009 will continue. The forecasted growth of deposits in 2010 is at the level of 2.5% of estimated GDP, which is an equivalent of 70-74 million euro of growth.

YesThe assumption used is that there will be a mild recovery of deposit potential in the coming period, i.e. that the deposit growth trend since May 2009 will continue. This growth is slower than the other scenario and it is estimated at around 25-30 million euro in 2010.

Further drawback of portfolio investors

YesIn terms of the portfolio investments in the first nine months of 2009, there was an inflow of 33.4 million euro, which is 72.5% lower than in 2008. Investments into national securities were 16.6 million euro, which is 50.9% less than in the previous year, while the withdrawal of monetary assets invested into foreign securities was 14.2 million euro. At the same time outflow of funds at the account of portfolio investments was 66.5 million euro. The largest portion of the outflow of 47.9 million euro was from investments of residents into foreign securities, while 18.6 million euro was withdrawal of funds invested into national equity securities.

NoThe assumption used is that there will be a mild recovery in inflows from investments into national securities.

No

Unemployment growth NoEven though the expectation was that as a result of significant downturn of the economic activity there will be an unemployment growth due to rather rigid labour market, the number of employees in the first nine months of 2009 was 174,418 and it was higher by 5.5% if compared to the same period of the previous year, while the number of employees in September was 4.6% higher if compared to the end of the previous year. Broken down by individual sector, the highest growth was in real estate related activities – 26.9%, hotels and restaurants – 19.2%, construction – 17.7% and corporate and households trade 11.7%.

Yes In 2010 layoffs will be inventible, at least in the segment dealing with the restructuring of export companies, thus an increase in expenditure for technological redundancy payments and increase of unemployment (which as an economic indicator has a time lag in times of crises, etc) are expected. The estimate is that these costs could lead to an increase of expenditures in excess of 1% of GDP. The estimated growth of unemployment is 1 p.p. since the assumption is that the public works will affect absorption of one segment of unemployed persons.

Yes In 2010 layoffs will be inventible, at least in the segment dealing with the restructuring of export companies, thus an increase in expenditure for technological redundancy payments and increase of unemployment (which as an economic indicator has a time lag in times of crises, etc) are expected. The estimate is that these costs would definitely exceed 1% of GDP, while the estimated growth of unemployment will be 1.8 p.p.

Stagnation and deferral of investment projects

PartiallyThe feature of capital-financial account trends in the first

PartiallyIf the FDI inflow structure is observed, excluding the

Yes There will a further drop in

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ten months of 2009 was a record inflow of FDI and net outflow on portfolio accounts and other investment accounts. According to preliminary data, net FDI inflow (inflow less outflow) in the first ten months of 2009 was 764.7 million euro, which is 69.3% more if compared to the same period of 2008. Total FDI outflow in the observed period was 857.7 million euro. In view of month-by-month data, the highest FDI inflow is recorded in September when the inflow was 314.9 million euro and was a result of the partial privatisation of EPCG.

EPCG privatisation and recapitalisation, there is a drop in investments in the core capital in addition to drop in investments into real estate. The assumption is that even in 2010 a certain number of projects will be deferred because of the fact that price of capital is still high and due to an increased risk.

investments in the real estate market as well as in the core capital of companies.

Deferred implementation of large-scale infrastructural projects

PartiallyPrimarily as a result of reduced inflow of tax revenues, the Budget revision reduced the level of funds allocated to capital investments.

NoSigning of the Concession Contract for construction of the first section of the highway, as well as signing of concession contracts for capturing value of military property by constructing tourism and residential complexes in the Littoral, have created contractual prerequisites for investments to start. Individually each of the investments is important in its scope and exceeds those currently implemented in Montenegro.At the same time, if infrastructural investments contracted through so-called “contract” loans are added to the capital budget, assuming that the announced arrangements with international financial institutions turn into effect, and then the total capital investments would be at higher level if compared to the previous years.

YesAdditional financing of infrastructural structures, including the Bar-Boljare Highway; In order to analyze and have a good quality management of fiscal risks arising from this activity, the Ministry of Finance is preparing various scenarios of the fiscal envelope in order to calculate fiscal impact of the construction of the Bar-Boljare Highway, as well as a cost of direct borrowing of the sate if the entire highway is constructed.

Drop in oil and oil derivatives prices, as well as prices of other energy sources

Yes No No

Stagnation – drop of aluminium prices

Yes No Yes

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Quantification of the “Base Scenario” and “Crisis Scenario”: Based on the scenarios articulated on qualitative bases (see Table 8), Tables 9 and 10 state basic quantitative features of both the “Base Scenario” and of the “Crisis Scenario”:

Table 9: Main macroeconomic indicators of the “Base Scenario” for period 2010-2012

Key Macroeconomic Indicators of the “Base Scenario”

2010 Forecast

2011 Forecast

2012 Forecast

Real GDP growth 0.5% 3.0% 4.0%

Nominal GDP growth 3.8% 6.6% 7.6%

Inflation 2.0% 3.0% 3.0%

Current account deficit (as % of GDP) 17.1% 15.9% 16.0%Net Foreign Direct and Other Investments(as % of GDP) 15.4% 16.9% 16.8%

Domestic Loans (as % of GDP) 77.1% 75.4% 74.0%

Bank Deposits (as % of GDP) 52.3% 53.7% 54.2%

Table 10: Main macroeconomic indicators of the “Crisis Scenario” for period 2010-2012

Key Macroeconomic Indicators of the “Crisis Scenario”

2010 Forecast

2011 Forecast

2012 Forecast

Real GDP growth -2.0% 3.0% 4.5%

Nominal GDP growth 1.9% 6.1% 7.6%

Inflation 2,0% 3.0% 3.0%

Current account deficit (as % of GDP) 15.9% 15.9% 16.0%Net Foreign Direct and Other Investments(as % of GDP) 15.9% 16.8% 16.9%

Domestic Loans (as % of GDP) 77.7% 76.1% 77.8%

Bank Deposits (as % of GDP) 52.6% 54.1% 54.1%

Arguments for the forecasted GDP growth rate according to the “Base Scenario” and “Crisis Scenario” respectively

Concept of Calculating the Economic Growth Rate: Forecasts of the GDP trends in Montenegro for the period 2010-2012 are based on so-called expenditure method which consists of following elements: (i) personal consumption of households, (ii) public spending, (iii) trade balance of goods and services, (iv) gross investments into fixed capital, and (v) inventories. In preparation of the scenario, certain forecasts of prices and labour market trends were also used.

Personal Consumption of Households: Personal consumption in 2009 had a significant downturn, due to effects of the global economic crisis, and dropped for almost 9 p.p. (by 314.0 million euro) if compared to 2008. Significant decline of credit activity of the banking system (drop in credits of almost 8% annually), connected with the stagnation of nominal

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and reduction of real wages, especially in the public sector, decrease of FDI inflows into real estate for almost 50%, have all affected the private consumption in 2009 to be estimated at 72.4% of GDP.

According to the “Base Scenario”, having in mind further expectations of low external demand, high costs of capital at the international market, restrictive fiscal policy in the area dealing with the compensation of employees, and only mild recovery of the credit activity, the assumption for 2010 is that the private consumption of households will increase to the level of 72.8% of GDP, or for additional 100 million euro if compared to 2009. It is important to mention the fact that Montenegro does not have data on currency in circulation. This complicates quite extensively the forecast of the private consumption level. The general assessment is that only the second quarter of 2009 started to reflect the slowdown of the consumption in terms of the households’ consumption, which indicates a relatively high liquidity level of the private sector in the period preceding the first signs of the financial-economic crisis. For the period 2011-2012, the “Base Scenario” relies on the assumption that the private consumption will return to the new level of long-term balance of 73.5-74.7% of GDP. Primary sources of growth of the private consumption share are based on the new reduction of the unemployment rate, growth of economic activity, more pronounced credit activity of the banking system and growth of nominal wages. On the other side, the new private consumption equilibrium at this level should not cause higher inflationary pressures, while on the other side it would reduce the level of the current account deficit of the balance of payments, which was based on the import of consumables in 2007 and 2008, guided primarily by the private sector demand.

According to the “Crisis Scenario”, as a result of the restrictive fiscal policy dealing with the wage policy, stagnation of the FDI inflow into real estate, weak credit activity especially in the area of consumer loans, the personal consumption in 2010 remains almost at the level of 2009 having a nominal growth of around 52 million euro if compared to the level from 2009. After 2010, the economic recovery is expected, as well as return of the private consumption level to 74% of GDP in 2012.

The difference of two scenarios regarding the private consumption in 2012 may be estimated to around 90 million euro, which is an equivalent of 1.9% of GDP estimated under the “Base Scenario”.

Public Spending: Decrease in import and export as early as the end of 2007 caused the reduction of the balance of payments deficit, but a reduction of the Budget inflows as well. The general assumption of both scenarios is that due to contracted growth of the Montenegrin economy in the forward period one should take into account roughly the same level of the Budget revenues in respect of estimated revenues for 2009. Furthermore, Montenegrin public finances will be exposed to following factors: (i) orientation towards the balancing of the Budget until 2012; (ii) decreased borrowing options in the international market; (iii) the EU integration process requires allocation of significant funds for these purposes (part of these costs will be covered by using pre-accession assistance funds); (iv) continued construction of the Bar-Boljare Highway requires allocation of significant funds as part of assumed obligations; (v) regular servicing of foreign and internal debt; and (vi) social program for safeguarding the population most affected by the consequences of the global economic crisis.

Following assumptions were used for the development of the medium term expenditure framework: (i)

Continued reduction of tax pressure by reducing and equalising the personal income tax rate from 12% in 2009 to 9% in 2010: This measure has a significant impact on creation of a more incentivising framework for the development of the private entrepreneurship

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and an increase of competitiveness as a result of a more significant reduction in effective tax rates, as well as reduction of employment in the “grey economy” segment and bringing it into legal economy. At the same time there will be an increase of contributions at the expense of employees from 17.5% to 24% and reduction of contribution rates at the expense of employers from 14.5% in 2009 to 10% in 2010 (9.8% contribution for compulsory social insurances and 0.2% contribution for the Labour Fund). In this manner the overall costs for employers is reduced which has significantly impacted relieving employers of obligations, reducing business barriers and increasing competitiveness. Moreover, in 2010 the obligation of advance payment of corporate profits tax was also abolished, which has significantly relaxed the private sector in terms of both liquidity and administrative procedures.

Limiting the level of the current public spending: Reduction of its share in GDP from around 40% of GDP in 2009 to some 34.2% in 2012 is envisaged, whereby the nominal amount of the current Budget spending will remain almost unchanged.

Continued implementation of the capital budget of Montenegro of 3.5% of GDP annually is planned along with the reduction of the current public and budget spending levels.

Continued payment of liabilities arising from the old foreign currency savings and restitution, whereby the repayment of liabilities arising from the restitution is limited to 0.5% of GDP annually. At the same time, regular servicing of national and foreign debt will continue.

Use of the EU pre-accession funds – IPA funds, whereby the country will have at disposal up to 33 million euro annually in the period 2011-2013, depending on the implementation schedule of proposed projects.

Balance of trade in goods and services: Drastic downturn of the foreign-trade balance during 2009 as a result of the global financial crisis is a consequence of action of both external factors (low external demand, primarily of the EU market, as well as the drop in prices of core export products, aluminium first of all) and internal weaknesses of the Montenegrin export structure (principally the low competitiveness of production sectors). Namely, due to significant drop in aluminium prices in world markets, the Aluminium Plant was very quickly pushed-out from the market as a result of high production costs. Thus in 2009, primarily due to decrease of export of aluminium and steel, the forecasted drop in export of goods is 46.1% which sets back the country to the 2001 export level. It is sufficient to mention that for the first six months of 2009 the export of goods in Montenegro without aluminium and steel was only little above an equivalent of 8% of GDP. On the other hand, reduced inflow of funds from abroad, slowdown of economic activity, decreased liquidity of the economy and reduced aggregate demand in 2009 led to drastic reduction of import which is estimated to be almost 40%. The biggest drop was in the segment of general consumption commodities, electricity import (due to reduced production of the Aluminium Plant) and of vehicles as well.

Under the assumption of the “Base Scenario” i.e. the assumption of mild growth of GDP, growth of aluminium prices in the world markets, consolidation of the Aluminium Plant and commencement of works of the Bar-Boljare Highway, the forecast for 2010 is simultaneous growth of export and import, whereby the import will have somewhat higher growth absorbing the effects of the highway construction. Based on such assumptions, this scenario envisages for the current account deficit in 2010 to be at the level of 17.1% of GDP. For the next two years the assumption of the “Base Scenario” is that the current account deficit stated as the GDP share will be stable at the level of around 16% of GDP, first of all as a result of growth of export of goods which should grow at the rate of 10-15%, then as a result of regaining of markets of base metals which were lost during 2009, as well as growth of export of services the growth of which would be balanced at the level of 5-8% annually.

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Forecast on trade in goods and services trends in 2010 relies on the four basic assumptions: (i) EU economy is recovering with a rate forecasted in documents of IMF, ECB, EBRD and WB; (ii) highway construction as well as other capital investments planned for 2010 are implemented according to the planned schedule; (iii) tourism season in the coming period continues the growth which was the characteristic for the period 2006-2008; and (iv) the Aluminium Plant commences regular export at the level which is not less than 70% of the production from 2008.

According to the “Crisis Scenario”, in 2010 the export of goods will stagnate as a result of postponing the finding of the solution for the Aluminium Plant, thus the growth of export of goods in 2010 is only 6% if compared to 27% what is planned under the “Base Scenario”. On the other had due to low public spending and private consumption of households, the import also stagnates having the growth of only 1.6% if compared to 2009, which is considerable lower that the growth of 8.15% planned in the “Base Scenario”. On the medium-run, precisely in 2012 and 2013, the “Crisis Scenario” envisages the stabilisation of the export trends based on the assumption that in 2011 the large Montenegrin export companies will manage to regain lost markets, especially those of the EU. Therefore, the forecast for export of goods in 2011 is 28% and 14% in 2012. These trends would reduce the current account deficit of the balance of payments in 2012 to the level of 16% of GDP, which is almost half less than in 2008.

Gross investments in the fixed capital: During 2009, it seemed initially that the FDI inflow was one of the macroeconomic aggregates not being significantly affected by the global financial crisis, even though the neighbouring countries were facing significant decline of FDI inflows. In case of Montenegro, the net FDI was one of the elements that have assisted in the prevention of a more pronounced economic activity downturn. The structure of the FDI inflows is significantly changed if compared to previous years, when investments into real estate were dominant. Investments into national companies and banks became dominant, where the significant part is effectuated in the form of inter-company debt, while the investments into real estate were significantly lower source of FDIs.

In terms of the level of investments into the gross fixed capital, it is noticeable that in 2009 there was a significant drop in the level of this category in the GDP structure of only 14.7% of GDP if compared to the previous year, when the estimated investments into gross fixed assets were around 27.8% of GDP. Reasons for an important downturn of this category in 2009 come from the fact that only few companies had new investments in fixed or working assets in this year, as well as that they were investing in growth of inventories. Namely, as a result of reduced credit activity of the banking system during this year, of pronounced reduction of private sector liquidity, as well as due to the fall in external demand and real estate prices, the investments into fixed capital were considerably reduced. The companies were primarily focused to utilize existing capacities in a quality manner, to adjust costs and level of production, as well as to utilize inventories in respect of reduced demand, thus the need for additional investments into fixed capital was limited.

According to the “Base Scenario”, projections are that there will be a mild growth of investments into fixed capital in 2010, and its share in GDP for that year is forecasted to be at the level of 15.6% of estimated GDP, as a result of somewhat more active but not excessively active credit policy of the banking system, somewhat better liquidity of the system as well as due to the recovery of the world economy. The assumption is that companies will focus on recovering lost markets in 2010, as well as to reach production level from previous period. Amidst, as a result of restrictive fiscal policy, it is to be expected to have a limited growth of gross investments into fixed capital as a result of decelerated implementation of capital public works, as well as due to further stagnation of new works in the construction sector. Distinct large investments into gross fixed capital are not expected in the subsequent years either, but the focus will be on the more efficient use of existing

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capacities. Investments into gross fixed capital are thus projected to be at the level of 16.4% of GDP in 2011 and 16.7% of GDP in 2012.

According to the “Crisis Scenario”, due to further economic activity downturn, a further decline of investments into gross fixed capital is to be expected; thereby investments in this category could be up to 1% less in 2010 if compared to 2009, since companies would primarily focus on maintaining their solvency and to a lesser extent to new investments.

Inventories: Items from financial reports for period 2007-2008 were used to assess the level of inventories. The level of inventories in 2009 reflected the expected market behaviour of companies in global crisis circumstances. Namely, decline of demand, both the internal and external one in almost all sectors, caused stockpiling of inventories, which were estimated to be 71 million euro in 2009. Reduction of the level of inventories is expected during the next year in both the “Base” and “Crisis” scenario, due to adjustment of production to existing demand, which were in an obvious mismatch (demand too low, plus production impulse based on the 2008 demand). According to the “Base Scenario”, there will be an abrupt reduction in inventories in 2010 as a result of expansion of the economic activity and private consumption. In the next two-year period, inventories should stabilise at the level of 0.1-0.4% of GDP. According to the “Crisis Scenario”, consumption of inventories in 2010 is forecasted to take place with slower pace than the one in the “Base Scenario” due to slim aggregate demand. Thus, the net difference of “unused” inventories in the “Crisis Scenario” and in the “Base Scenario” for that year is 39.8 million euro. In the case of the “Crisis Scenario”, a decline in inventories is forecasted for 2011 and 2012 due to economic activity expansion.

Prices: The prices trend in the coming period should not represent the source of instability of the Montenegrin economy. Videlicet, low demand and by that low consumption level, drop of real wages (in September 2009, if compared to the previous quarter, the average wage as well as the average wage without taxes and contributions have recorded a drop of 2%), unemployment growth which is expected in the next year, alongside restrictive fiscal policy and limited credit growth, do not leave sufficient room for inflationary pressure. The present level of base inflation supports this argument, which indicates a downward trend of inflationary expectations. In October 2009, the base inflation was 1.73%, while the annual base inflation for the same month was 1.43% and it was 3.7 p.p. lower if compared to the annual base from March 2009. Having in mind that the base inflation is a relative indictor of the long-term inflation, the assumption is that there will be no internal inflationary pressures in the next period.

Possible source of instability could be expected if there would be significant changes in prices in the world market of energy sources, fuels, as well as of agricultural products, which are the external sources of price instability. Possible impulse (even though rather unlikely) of inflationary expectations could be also caused by an extensive increase of prices of products the prices of which are regulated by administration (through the increase of excise taxes). Consequently, in both scenarios the level of projected inflation measured by the consumer prices index remains at the level of 2%.

In terms of the trends of deflators, the characteristic of the previous period is that the level of deflators in Montenegro exceeds the inflation level, which is an indication of non-competitiveness of prices of domestic products and services. Therefore, the deflator was significantly higher than the inflation during 2007 in spite of extremely high import oil prices which led to rise of inflation above the deflator level in other countries. Adjustment of prices of domestic products and services is expected in the coming period, in order to adjust them to decreased internal demand, thus the assumption of both scenarios is that an equalisation of the GDP deflator level and CPI will take place in the period 2011-2012 and will be around 3% annually.

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Labour Market: The labour market in Montenegro, as compared to majority of neighbouring countries, almost has not even felt consequences of the economic crisis until the end of third quarter of 2009. According to data of the Employment Office, the unemployment rate was 10.35% in September 2009 and it is lower for 0.36 p.p. if compared to the rate from the same month of previous year. Low unemployment rates were recorded in summer months (lowest one in August – 10.17%), which could be attributed to seasonal employment. Additionally, it should be mentioned that the additional reason for such low unemployment rates was the change in legislation in 2009 whereby rights and obligations of non-residents were made equal to the one of the residential labour force.

In 2009, the Government of Montenegro signed the Agreement with the Union of Employers, whereby the employers undertook, among other things, that the layoffs during the crisis would be only done as a last instance measure. It is extremely important to highlight that the unemployment, as an economic activity indicator, has a time lag, as a rule, if compared to other indicators, as well as that it has a downward trend over the last several months. Growth of unemployment rate of 0.18 p.p. in September 2009, if compared to the previous month could be a reflection of beginning of recording the labour market problems from previous period, precisely difficulties in operation of some economic undertakings and administrative recording of “surplus” of employees with a certain time lag. Having in mind the announced resolution of problems in several companies having a long-standing surplus of labour force, including also the Aluminium Plant as the largest export company, it is realistic to expect that the unemployment rate will grow. Moreover, the enterprises will not be able to rely on the reduction of wages in the next period, as a preventive measure of reduction of production costs, which was an often-used option since September 2009, but they will have to adjust their production by reducing marginal operating costs through the reduction of the number of employees. The assumption in the “Base Scenario” is that in 2010, the unemployment rate could reach the level of 11.9%, setting it back to the 2007 level, while the “Crisis Scenario” envisages even higher rate – precisely 13.0%.

In respect of the labour productivity in Montenegro, there was a significant reduction in 2009. In fact, in spite of the real economic activity downturn for an estimated 5.3% in 2009 there was an employment growth of estimated 5%, meaning that the estimated labour productivity decline in that year is 1.8%. The “Base Scenario” for 2010 envisages the productivity growth of 3.5% due to unemployment growth and marginal growth of real GDP. The labour productivity could grow at rate of around 4%, within the “Crisis Scenario”, due to significant layoffs of labour force to increase the production efficiency. It is obvious that the financial crisis pointed to the existence of the labour market rigidity in Montenegro, non-resilient in terms of the large economic shocks, whereby the new adjustment of labour force level is very slow, which altogether has direct impact on labour productivity changes.

The wages in Montenegro, unlike the employment growth, stagnated and even recorded a decline. This stresses out that structural changes in the labour market caused by the global financial and economic crisis in Montenegro were manifested through drop in wages. The assumption used is that after the nominal wage growth of 17.5% in 2008, there will be a nominal drop of wages of 1.7% in 2009. Due to mild recovery of the economic activity in 2010, envisaged in the “Base Scenario”, an upward correction of nominal wages in the real sector could be expected in line with the forecasted inflation rate, while there will be an downward correction in the public sector in accordance with legislative changes. In forward years, having in mind fiscal policy measures directed at reduction of the public spending in all levels, a significant growth of nominal wages cannot be expected, thus the wage growth will be adjusted with the labour productivity level and inflation, which corresponds to the growth of nominal wages in 2011 and 2012 of 5% and 6.2% respectively in both scenarios.

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3. PUBLIC FINANCES

The high growth rates were the characteristic of the Montenegrin economy in the period 2006-2008. Macroeconomic and political stability has provided for a synergy effect in terms of the more pronounced interest of foreign investors, which has resulted in impressive inflow of foreign direct investments. The foreign direct investments, alongside the large growth of banking loans, have influenced the increase of import growth rates and growth of personal consumption and public spending, which started the cycle of the dynamic economic growth and the growth in quality of life of Montenegrin citizens. Moreover, this period was featured by sizeable dynamics in the capital and real estate markets, as well as important increase in revenues of the Central Budget of Montenegro, as well as in budget of local self-governments. High economic growth was also followed by reinforcement of some of the trends, such as the “overheating” of the economy, increase of the current budget expenditures, inflation growth and high balance of payments deficit.

In the long run, the stated positive economic trends were hardly sustainable, thus the medium-term macroeconomic and fiscal forecasts developed at the time were already projecting gradual decrease of the economic growth rate and foreign-economic disbalance and a gradual decline of public spending in the fiscal area with simultaneous reduction of the fiscal burden. However, the occurrence of the global economic crisis and its repercussions have accelerated the need for faster structural and fiscal adjustments, as well as budgetary adjustments.

Consequences of the global financial and economic crisis, felt in Montenegro in the last quarter of 2008 and continued during the entire 2009, have substantially worsened the fiscal performance of the country. In 2009, there was a drastic reduction of the scope of source public revenues if compared to the previous year. Even though the Government responded with a series of saving measures to the reduction of the public revenues, the public finances deficit was increased from only 0.4% of GDP in 2008 to almost 4.0% of GDP in 2009. However, in 2009, the relative stability of the banking system and prudential fiscal responses of the state to the downturn have for the time being restrained the significant negative impact of the crises on the public finances.

The estimate of public spending in Montenegro in 2009 and over the medium-term framework of 2010-2012 is based on the estimated data on GDP trends (the estimate is that the GDP retraction in 2009 will be around 5.3%), data on public spending trends in the period from 2006 to 2008, outturn of the public spending for the first eleven months of 2009 and estimated negative impact of the global economic crisis on Montenegro. Furthermore, the fiscal effect of main structural reforms was taken into consideration, as well as the fiscal impact of changed legislation dealing with tax rates.

Strong impact of the global economic crisis on Montenegro, in particular on its public finances, has determined the main assumptions for the development of the medium-term fiscal scenario of the country for the period from 2010 to 2012, which are presented in Table 11 in terms of some core elements. The context of the global uncertainty and growing probability for the impact of the global economic crisis to continue on the Montenegrin economy definitely featured the forecasts in both of the scenarios.

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Table 11: Basic Macroeconomic Indicators and Fiscal Parameters for 2008 and Forecasts for the Period 2009-2012.

Macroeconomic and fiscal envelope

( in % of GDP)

2008 2009 2010 2011 2012

Outturn

Forecast

“Base Scenari

o”

“Crisis Scenari

o”

“Base Scenari

o”

“Crisis Scenari

o”

“Base Scenari

o”

“Crisis Scenari

o”Nominal GDP growth (in %) 16.27 -0.10 3.80 1.90 6.60 6.10 7.60 7.60Real GDP growth (in %) 4.00 -5.30 0.50 -2.00 3.00 3.00 4.00 4.50Public Revenues 49.58 43.10 41.89 40.17 42.06 40.33 41.10 39.41Consolidated Public Spending 49.96 47.09 46.23 45.99 43.54 43.54 41.06 41.06Deficit/Surplus -0.38 -3.99 -4.34 -5.83 -1.48 -3.22 0.04 -1.65Interest 0.76 0.86 1.04 1.04 1.04 1.04 1.03 1.03Primary deficit/surplus 0.38 -3.13 -3.30 -4.78 -0.44 -2.17 1.07 -0.62Increase/reduction of deposits -2.79 -1.87 -2.76 -4.28 -0.36 -2.10 0.07 -1.62

The first scenario called the “Base Scenario” is consistent with the adopted Budget of Montenegro for 2010 and is based on the assumption of approximately equal level of the budget revenues in 2010 if compared to the estimated revenues for 2009. The strategic objective of this scenario is to eliminate the public finances deficit by 2012, primarily by reducing the public spending, which is significantly reduced by the Revision of the 2009 Budget and the Law on Budget for 2010.

Apart from the “Base Scenario” of public finances, which is based on moderate recovery of economy in 2010 (forecasted real growth of 0.5%), the “Crisis Scenario” is also developed which is based on the assumption that the economy of Montenegro will have negative economic growth in 2010 as well (at the level of -2.0%). As presented in the Table 11, the core difference of such fiscal scenario if compared to the “Base Scenario” is that due to additional reduction of public revenues the pace of the public finances deficit reduction in the “Crisis Scenario” will be slower than the one envisaged in the “Base Scenario”.

In spite of the need to increase expenditures required for the efficient implementation of the EU accession process of Montenegro8, the expenditures for financing of social programs for safeguards of the population mostly affected by the consequences of the economic crisis, as well as expenditures for financing of the continuation of the construction of the Bar-Boljare Highway9 and other strategically important infrastructural projects, both of the scenarios have significant fiscal consolidation guided by the reduction of current expenditures as their feature.

8 The full utilization of the pre-accession assistance IPA is the one being counted on in this case.9 The capital budget for 2010 has allocated 25 million euro as participation of the Government of Montenegro at the account of contribution to the construction of the first section of the Smokovac-Mateševo Highway, in line with the Concession Contract signed with the Croatian Consortium led by the Konstruktor company.

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3.1 Public Finances Sector – Fiscal Framework and Debt Management

3.1.1 Public Finances Trends in the Period 2008 - 2009

In 2007, the consolidated public finances of Montenegro consisting of the central government budget, budgets of 5 state funds and local-self government budgets (19 municipalities, Capital, and Historical Royal Capital) were marked by a significant increase of public revenues and surplus of public finances of around 6.5% of GDP.

As early as in the last quarter of 2008, the contraction of the economy led to the worsening in the public finances sector. Even though the high economic growth almost until the end of the year maintained revenues from taxes at high level, the total public revenues (their relative share in GDP) were reduced as a consequence of economic activity slowdown, especially in the real estate sector; decreased export and import; and also due to reduction of rates for mandatory social contributions and reduction of non-tax revenues. Since there was a significant increase at the side of the consolidated public spending primarily due to the 30% increase of wages in the public sector and an increase of social transfers and of the capital budget, already in 208 the budget entered the zone of public finances deficit of 0.4% of GDP after three years being in the zone of high surplus.

Under the influence of the global financial and economic crisis, the negative trends in performance of the public finances of Montenegro continued during 2009. The reasons for worsening of the public finances performances of the country are both on the side of the drop in public revenues and further growth of budget expenditures.

As stated in the Table 12, due to dramatic reduction of the economic growth and imports, the source public revenues were reduced by almost 14%; from 1,544 million euro in 2008 to 1,329 million euro in 2009. The biggest drop was in the indirect taxation revenues (VAT and customs), which were having a strong import element, thereby the recued imports, trade and production activities led to their reduction. Additional reduction in VAT revenues was also due to abrupt drop in personal consumption. The corporate profit tax revenues were also affected due to a declining corporate profitability. As a result of increased tax burden in terms of the excise taxes (this was the only source revenue that recorded growth) there was an increase in revenues from this source. The excises on mineral oils and tobacco and tobacco products were increased, all in line with alignment and harmonisation of Montenegrin tax legislation with the EU Directives. Finally, revenues from the personal income tax remained at the level from 2008, due to unchanged employment in the economy.

On the other side, the expenditures were increased in the same period by 9.1% or by around 150 million euro, before the revision of the Budget was adopted in July 2009.

Table 12: Overview of Public Finances in 2008 (outturn) and 2009 (forecast)

DESCRIPTIONOutturn 2008 Forecast 2009

mil € % of GDP mil € % of GDP

CURRENT PUBLIC REVENUES 1544.44 49.58 1328.91 43.10Taxes 926.40 29.74 794.14 25.76Contributions 339.91 10.91 286.97 9.31Fees 36.09 1.16 31.55 1.02Charges 165.76 5.32 112.01 3.63Other revenues 67.28 2.16 55.83 1.81

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Inflows from loan repayment 9.00 0.29 48.41 1.57CONSOLIDATED PUBLIC SPENDING 1556.55 49.97 1451.92 47.09CURRENT PUBLIC SPENDING 1245.67 39.99 1239.40 40.20Current expenditures 574.95 18.46 545.68 17.70Transfers for social care 350.42 11.25 408.36 13.25Transfers to institutions, individuals, NGOs and public sector 237.55 7.63 233.63 7.58Total capital expenditures 310.89 9.98 212.52 6.89Borrowings and loans 63.51 2.04 29.72 0.96Reserves 19.19 0.62 22.00 0.71DEFICIT/SURPLUS -12.12 -0.39 -123.01 -3.99FINANCING 12.12 0.39 123.01 3.99Domestic financing -110.79 -3.56 -125.25 -4.06Foreign Financing -2.65 -0.09 80.96 2.63Grants 4.22 0.14 5.40 0.18Revenues from privatisation or deposits 38.56 1.24 109.74 3.56INCREASE/REDUCTION OF DEPOSITS -87.00 -2.79 -57.56 -1.87

It is important to highlight that the structure of source revenues changed in 2009 if compared to previous years. In fact, the growth of share of direct taxes (income taxes and social contribution) in total taxes is notable, while at the same time there is a reduction in share of indirect taxes (40%:60% for direct taxes). Namely, the simultaneous effect of lower tax rates of personal income tax and corporate profit tax, and continuity in removing business barriers in the Montenegrin economy in 2009 have led to the increase of revenues from this source, pointing out in that way the growth of employment and wages, as well as the reduction of the grey economy. At the same time, there was a significant reduction in revenues from the value added tax on imported goods and tax on international trade and transactions. During previous years due to a high share of VAT on imported goods, the structure of totally collected VAT was 75:25 – VAT on imported goods : VAT on internal trade, while in this year as a result of reduced revenues from VAT on imported goods this ratio changed to 63:37 and this trend can be expected in 2010 and beyond.

On the public spending side, there was a reduction in 2009, even though much lower if compared to the revenue side. The consolidated public spending in that year was 1,452 million euro, which is by 7% less than in 2008. The reduction of the total spending was accompanied by significant changes in its structure. Thus, on one side there is an increase in transfers for social care as part of counter-crisis measures, while on the other side there are significant reductions as part of the savings program which have reduced all discretionary outflows up to the level which enables undisturbed functioning of spending units. Of all the saving measures in the area of current outflows, the most important were the reduction of other wage compensations in the public sector and restrictions in the field of expenditures for materials.

Sizeably lower generation of public revenues of Montenegro, which resulted in the first half of 2009, required the correction in both revenue and expenditure side of public finances, which resulted in the revision of the 2009 Budget, adopted in July. The basic assumptions used for the revision are as follows:

Estimated drop in revenues of the Budget of Montenegro and state funds of 212.4 million euro or 6% of GDP, compared to the previously planned level of revenues;

Reduction in scope of consolidated public spending in such manner to keep the cash deficit at the level of 3% of GDP, precisely within the established Maastricht criteria; Specifically, the revision envisaged that the deficit would be 93.74 million or 2.65% of GDP;

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Securing financing of deficit and debt amortisation with new inflows from financing (mainly borrowings in the form of loans); Signing contracts and issuing Treasury Bills in the amount not exceeding 240 million euro are envisaged for financing of deficit and debt repayment;

Issuing of state guarantees of 167 million euro for loans in support of production and export (KAP, Railways, newspaper Pobjeda, Montenegro Airlines, etc).

As stated in the Table 2, the latest projections for 2009 indicate that the deficit will be higher than planned in the revision of the 2009 Budget due to unfavourable trends on the revenue side of public finances, and that the public finances deficit in 2009 will reach the level of 123 million euro or 4.0% of GDP as a result of deferred recession effects on tax revenues and social transfers. The deficit is mainly financed by commercial arrangements with foreign banks and privatization proceeds, avoiding in such manner the crowding out effect.

The analysis of trends of certain spending categories of the central budget of Montenegro in the period 2006-2009, i.e. in the three pre-crisis years when the state recorded exceptionally high economic growth rates and in 2009 as the year of the financial crisis, is presented in the remaining part of this section. This analysis is important in order to get a proper overview of what were the most important sources of the budget spending growth in the previous period in order to explain corrections in 2010 and beyond.

The growth of the budget spending in Montenegro in previous years was caused to a great degree by growth of wages and pensions. In the period 2006-2009, due the increase of minimum labour cost and multipliers of salary grades, the gross wages of employees increased by about 63%, thus the total wage bill of the public sector (without local self-governments) in 2006 was around 210 million euro while in 2009 it was planned, based on the Budget revision, at around 340 million euro. By identifying the part of wages being paid through transfers from the budget (healthcare institutions, University of Montenegro, Montenegrin Academy of Science and Arts, etc) we obtain the amount of gross wages of around 371 million euro as planned in the Budget revision. According to the data of the Ministry of Finance, the number of employees in the public administration, healthcare and education sectors in 2009 was 42.5 thousand, including trainees and employees based on a service contract. As far as pensions are concerned, the current number of users of rights from pension and disability insurance is around 110 thousand, which has caused an increase of expenditures for pensions, at the account of regular and extraordinary adjustments, from 199 million euro in 2006 to 321 million euro in 2009 or 61%.

Wages and pensions are the key element of fixed or mandatory expenses of the Budget of Montenegro, the share of which was around 75-80% in consolidated budget expenditures of the country in the period 2006-2009. As stated in the Table 13, according to the revision of the 2009 Budget, 76% of consolidated expenditures are defined in advance by way of legislation i.e. relevant laws and other applicable legal instruments in this area (general and sector-based collective bargaining agreements, laws and contracted obligations) – wages and other personal revenues, pensions, transfers for social protection, transfers to the University of Montenegro, transfers to political parties, interests, subsidies, etc. This indicates that those responsible for economic policy have very little room for discretionary spending.

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Table 13: Fixed and Discretionary Spending of the Budget of Montenegro, 2006 – 2009

DESCRIPTIONOutturn 2006 Outturn 2007 Outturn 2008 Revision 2009

mil € % share mil € % share mil € % share mil € % share

CONSOLIDATED EXPENDITURES

788.74 100.00 951.3

4 100.00 1272.03 100.00 1347.3

6 100.00

FIXED SPENDING 615.35 78.02 757.7

0 79.65 957.77 75.29 1025.69 76.13

DISCRETIONARY SPENDING

173.39 21.98 193.6

4 20.35 314.26 24.71 321.67 23.87

The Table 14 states expenditure of the Budget of Montenegro and of the state funds in the period 2007-2009. Expenditures for materials and services and capital expenditures are reduced by a portion of the expenditures being financed from international grants, and borrowings and loans, in order to have a clear picture of the budget spending level being financed from general and earmarked revenues.

Table 14: Current and Capital Budget of Montenegro, 2007 – 2009

DESCRIPTIONOutturn 2007 Outturn 2008 Outturn 2009

mil € % of GDP mil € % of

GDP mil € % of GDP

TOTAL (1+2) 947.1635.3

41264.8

540.9

91354.6

743.9

4

1. Current budget and budget of state funds 864.9632.2

71191.4

838.6

11241.9

140.2

8

Gross wages and other personal earnings 283.6110.5

8 376.4512.2

0 391.2912.6

9Expenditures for materials and services 135.26 5.05 158.32 5.13 167.44 5.43Current maintenance 22.63 0.84 22.15 0.72 5.53 0.18Interests 27.10 1.01 22.53 0.73 25.17 0.82Rent 4.92 0.18 8.36 0.27 9.66 0.31Subsidies 13.07 0.49 18.59 0.60 51.07 1.66Other expenditures 5.75 0.21 5.74 0.19 6.82 0.22Transfers for social protection 298.51

11.14 346.54

11.23 419.75

13.62

Social care rights 39.19 1.46 42.10 1.36 48.95 1.59Redundancy funds 11.42 0.43 30.21 0.98 22.39 0.73Pension and disability insurance rights 228.37 8.52 250.94 8.13 321.02 10.41Other healthcare rights 19.54 0.73 23.29 0.75 15.60 0.51Transfers to institutions, individuals, NGOs and public sector 55.41 2.07 74.76 2.42 74.49 2.42Capital expenditures of the current budget and funds 0.00 0.00 83.06 2.69 47.86 1.55Borrowings and loans 7.85 0.29 62.54 2.03 28.75 0.93Reserves 10.84 0.40 12.44 0.40 14.07 0.462. Capital Budget 82.20 3.07 73.37 2.38 112.76 3.66

The Table clearly shows that the current spending in 2008 was higher by 8% than in 2007, whereby the increase is almost equally distributed into following three categories: (i) wages and other personal earnings, (ii) transfers, and (iii) capital expenditures of the current budget; even though there were significant downward corrections in the revision of the 2009 Budget in respect of initially planned budget exactly of those line items.

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3.1.2. Fiscal risks in 2010

The following factors that might represent a greater or lesser risk for public finances of Montenegro in 2010 should be taken into account when macro-economic and fiscal indicators are projected for the subsequent period:

Banking sector condition; Although the banking sector balance is under consolidation, and liquidity growth trends are notable, as well as gradual decrease of the percentage of uncollected receivables and increase of the deposit level, this sector is still characterized by numerous problems. The most significant one is high exposure to the crisis affected economic entities and their employees, such as KAP (Aluminium Company), Željezara (Steels Company) and building companies, which represents a potential jeopardy for banks and it is the basic reason why their net-lending is currently negative. At the same time, the consolidation and still uncertain future lending policy of the largest bank in the system – Crnogorska Komercijalna Bank OTP, with limited lending to which Prva Banka Crne Gore is subject, as one of the largest banks in the system and the only bank with majority domestic equity, significantly contribute to uncertainty of the net lending estimates for 2010. Net positive lending of the banking sector in 2010 will be a definite signal that Montenegro is leaving recession.

Continuation of exposure of Montenegrin economy to external shocks; As a small open economy, Montenegro is very dependent on economic trends in its surroundings, primarily in the EU countries, therefore a slow recovery of economic growth in such countries will reflect on macro-economic and fiscal trends in Montenegro in the following year. To-date the overflow of the crisis through trade flows has mostly impacted the reduction of aluminium export, due to decreased external demand, decreased production of aluminium in Montenegro, as well as drastic reduction of its price in the international market. In addition to trade channels, the crisis overflows to Montenegrin economy by banking channels too. In 2009 there was a significant contraction of lending activity of banks (as a result of decreased access of domestic banks to capital and significant growth of its price), and this trend could continue in 2010 as well. The recovery or non-recovery of the lending activity of banks will substantially determine the trends in the real sector.

Dependence of the country on the trends in the tourism market; The international market of tourism services, and therefore Montenegro as a tourism destination is very exposed to external impacts. Summer tourism season in 2009 was approximately at the level of the previous year, with approximately the same number of tourists and financial effects. The trends in the coming years will be dominantly determined by the growth of global economy and international tourism market. Also, in order to attract a significant number of upscale tourists it required to improve the accommodation capacities and complementary tourist offer, which requires the support from the banking sector. This risk is boosted by visa liberalization for the countries from the region – the tourists from Serbia, Macedonia, as well as the citizens of Montenegro will be able to travel abroad with less barriers and expenses.

Uncertainty of the recovery of companies in the heavy industry sector; The current prices of aluminium and steel in the world market do not allow profitable business of these companies, which even in the short-term undermines their functioning. The restructuring of these companies is in process in order to reduce costs to the level that could facilitate profitable business operations.

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The decrease of public expenditures in 2010 for the purpose of ensuring sustainability of public finance system, will have negative effect in the form of additional contraction of aggregate demand; The fact is that public expenditures make a significant part of the overall demand in Montenegro. Since its share is nearly 30% of the country’s GDP, its contraction made for the purpose of stabilizing public finances will result in the reduction of the overall demand, and therefore unfavourable impact on rehabilitation of economic growth.

Significant increase of wages in the public sector in the previous years; The growth of public expenditures in the previous years was primarily caused by the growth of wages and pensions. In order to provide the sustainability of the public finance system, it is necessary to re-examine the policy of salaries and employment in the public sector. In other words, in order to ensure the growth of salaries in the subsequent years in accordance with the growth of work productivity, it is necessary to lead a robust wage policy in the public sector.

Issued guarantees and other implied obligations of the country; One of the measures for support to the real sector hit by the crisis was the issue of guarantees for approved loans. Crowded debts of economic entities will, if the negative trends continue in the real sector, increase the possibility for issued guarantees to be called, which would additionally burden the settlement of planned budget expenditures, due o the increase of the debt repayment.

Increase of the unemployment rate and lowering of wages may increase the pressure on social transfers from the budget; Similarly to all other countries hit by the crisis it is realistic to expect that the continuation of the crisis will be followed by the increase of the number of the unemployed, which will in its own right increase the pressure on the social transfers from the budget. This risk could become extremely significant in the context of potential termination of production in some of the largest industrial plants.

Incomplete certainty that the planned privatizations will be carried out within the envisaged deadlines; In accordance with the adopted plan the privatisation of some of economic entities that are still under the ownership of the state is envisaged in 2010. Still, the continuation of the current economic and financial crisis might lead to certain problems in implementing such plans, i.e. deadlines within which they would be implemented.

Potential problems related to access to the international financial market for the purpose of financing the deficit of public finances; Many countries around the world, particularly the most developed ones, significantly increased the deficit of their public finances in 2009, and the high level of the deficit will continue in 2010 too. All this leads to the conclusion that in 2010 there will be great demand for liquid funds in the international financial markets with potential crowding out of small borrowers from such markets.

3.1.3. Goals and basic directions of the fiscal policy in the following medium term framework

Taking into account the above mentioned fiscal risks and fact that the high level of public expenditures would lead to a longer and slower recovery of the Montenegrin economy, the fiscal policy defined the following basic goals and directions for the coming midterm period:

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Establishing of a sustainable public finance system through defining of fiscal “anchors“ and rules. The main fiscal anchors in the period until 2012 that are included in the “base scenario“ are: reduction of the current expenditures and state debt below 35%; balanced budget in 2012; restraining of the growth of the wage and subsidy fund through concurrent reduction of the share of mandatory costs; constant capital budget at the level of around 3.5% GDP and possibility of capital project financing through public private partnership models; structural revenues should cover the current spending and at least 50% of the capital budget, while after the stabilization of the economic situation the budget balance should have surplus at the level of about 2% GDP. In this way, the current public spending would move to the level of about 30% GDP after 2012, while the debt would move below this level.

Completion of reforms on the revenue side of public finances commenced in 2007; The reforms related to lowering of the personal income tax rates that commenced in 2007 will be completed in 2010, and thus Montenegro will become the most competitive in the region according to this parameter. After lowering the personal income tax rate to 12 % in 2009, it will be lowered to the final 9% in 2010. This measure significantly impacts the creation of an incentive-giving framework for the development of entrepreneurship and improvement of competitiveness, as well as the reduction of employment in “grey economy“, i.e. its inclusion in the legal flows. At the same time, the rates for contributions paid by employers will be lowered from 14.5% in 2009 to 10% in 2010. The lowering of the mentioned rate significantly impacts the reducing of the burden of employers, reduction of business barriers and improvement of competitiveness.

Continuation of public expenditure reforms directed to creation of a stimulating economic environment; In the period 2010 – 2012 fiscal and structural reforms of the public spending system directed to creation of a stimulating economic environment will continue. This will be achieved through: the implementation of public private partnership policies, particularly in the areas of education and health; further reform of the social system, with special accent on further parameter reform of the pension system with concurrent elimination of business barriers, which will provide for the competitiveness of economy and additional attraction of foreign direct investments.

Establishing of sustainable health and pension system; With the integration of the Pension Fund and the Health Insurance Fund in the Treasury in 2010, their inflows and outflows will be recorded and processed through the state Treasury. In this way the transparency of the budget and control of budgetary funds spending will be improved, and concurrently the liquidity too. At the same time, the transformation of the Development Fund is ongoing, and it will function as a state investment fund from 2010 and will not be a spending unit.

The following measures, i.e. economic and particularly fiscal policy instruments will be used for achieving these goals and directions: (i) creation of the conditions for a more flexible position of the Government in designing the budget spending, primarily through lowering of mandatory reserves in relation to the discretionary spending, (ii) leading of a robust employment policy in the form of rationalisation of the number of employees and use of internal transfers (legal possibility for transfer of an employee from one spending unit to the other), (iii) presenting of transfers according to economic classification that will improve the control and upgrade the transparency of spending of public resources, (iv) establishing of methodologies and procedures for defining the basic macroeconomic and fiscal indicators, such as for example the level of the current and capital spending, deficit and public debt, (iv) using of non-recurring budgetary revenues, primarily, for early repayment of debt incurred in 2009 and 2010, and in specific cases for lump sum payments of redundancy costs or work force retraining costs, (v) using of the EU pre-accession funds – IPA funds, where Montenegro as a potential candidate in the period 2011-2012 has funds available in the

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amount of about €33 mil on annual level, (vi) increase of the current spending only for development projects, with concurrent abandoning of non-rational public spending programs. 3.1.4. Medium term fiscal framework for 2010 – 2012

As already explained in the sub-section 2.2. and sub-section 3.1.2, this year’s EFP is based on the development of two macroeconomic and fiscal scenarios for the period 2010-2012. The basic difference between these two scenarios is related to the extent in which the macroeconomic and financial risks from 2009 will continue in 2010 as well. Thus, the first scenario called the “base scenario” on which the state budget for 2010 is based projects a mild recovery of economy in 2010, while the other, alternative scenario, i.e. “crisis scenario” is based on further deepening of the crisis in 2010. Both scenarios significantly differ on the revenue side (primarily as the result of different rates of the forecasted economic growth in 2010) and consequently in the forecasted scope of the deficit of public finances. Each of the two scenarios is in details presented in the following text of this section.

“Basic scenario” for 2010 - 2012

Fiscal projections in the “base scenario“ (Table 5) are based on macroeconomic projections of the mild growth of economic activity – GDP growth of 0.5% – since, due to weak diversification of economy, there is no economic base to provide for stronger recovery of economic growth, and thus the recovery of budgetary revenues. Whether the mild recovery of economy forecasted by the “base scenario“ will take place greatly depends on the fulfilment of the following assumptions: (i) banking system stabilisation – consolidation of the banking sector balance, decrease of the percentage of non-collected receivables, increase of the level of deposits and restoration of lending to economy and households, (ii) continuation of the positive trend of the inflow of foreign direct investments, and (iii) recovery of some significant indicators of Montenegrin economy, such as payment operations, turnover in retail and banking sector indicators.

Table 15: Basic macroeconomic and fiscal indicators of the “base scenario” for the period 2010-2012 (0.5 % growth in relation to 2009)

  2010 Plan 2011 Projection

2012 Projection

Mac

roec

onom

ic in

dica

tors

Nominal growth of GDP 3.80% 6.60% 7.60%Real growth of GDP 0.50% 3.00% 4.00%Inflation 2.00% 3.00% 3.00%Current account deficit 17.10% 15.90% 16.00%Net foreign direct and other investments 15.40% 16.90% 16.80%Domestic loans 77.10% 75.40% 74.00%Bank deposits 52.30% 53.70% 54.20%

Fisc

al in

dica

tors Public revenues 41.89% 42.06% 41.10%

Consolidated public spending 46.23% 43.54% 41.06%Deficit/Surplus -4.34% -1.48% 0.04%Interest 1.04% 1.04% 1.03%Primary Deficit/Surplus -3.30% -0.44% 1.07%Public debt level 39.50% 38.70% 34.20%Increase/decrease of deposits -2.76% -0.36% 0.07%

A fiscal “base scenario” has been produced based on macroeconomic indicators, and its basic indicators are presented in the lower part of Table 15. These indicators are included in the Montenegro Budget Law for 2010.

“Base scenario” of public finances of Montenegro is presented in Table 16, which is based on the real growth rate of GDP amounting to 0.5% in 2010, 3.0% in 2011, and 4.0% in 2012.

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Table 16: “Base scenario” of public finances for the period 2010 – 2012

O P I S Plan 2010 Projection 2011 Projection 2012 mil € % GDP mil € % GDP mil € % GDP

OWN SOURCE PUBLIC REVENUES 1341.02

41.89 1435.22

42.06 1509.21

41.10Taxes 820.47 25.63 877.24 25.71 917.88 25.00Contributions 323.93 10.12 346.39 10.15 364.62 9.93Duties 30.11 0.94 32.10 0.94 34.54 0.94Fees 110.02 3.44 117.28 3.44 126.19 3.44Other revenues 49.65 1.55 54.92 1.61 58.14 1.58Loan repayment receipts 6.84 0.21 7.30 0.21 7.85 0.21CONSOLIDATED PUBLIC SPENDING 1479.9

246.23 1485.8

143.54 1507.6

641.06

CURRENT PUBLIC SPENDING 1246.46

38.94 1249.04

36.60 1254.65

34.17Current expenditures 625.21 19.53 626.84 18.37 611.75 16.66Social security transfers 407.19 12.72 407.77 11.95 427.42 11.64Transfers to institutions, individuals, NGO and public sector 197.55 6.17 197.26 5.78 198.14 5.40

CAPITAL EXPENDITURES 233.46 7.29 236.77 6.94 253.01 6.89Borrowings and loans 4.48 0.14 4.52 0.13 4.55 0.12Reserves 12.02 0.38 12.66 0.37 12.80 0.35SURPLUS / DEFICIT -138.91 -4.34 -50.59 -1.48 1.55 0.04FINANCING 138.91 4.34 50.59 1.48 -1.55 -0.04Domestic financing -101.23 -3.16 -77.32 -2.27 -57.34 -1.56Foreign financing 56.66 1.77 38.20 1.12 -12.00 -0.33Donations 21.77 0.68 21.70 0.64 24.90 0.68Revenues from privatization or deposits 73.22 2.29 55.59 1.63 45.59 1.24INCREASE/DECREASE OF DEPOSITS -88.50 -2.76 -12.42 -0.36 2.70 0.07

The main direction of this scenario is to eliminate the deficit of public finances by 2012. Since, due to relatively low economic growth rate a very slow increase of source public revenues is forecasted, the main burden of fiscal stabilization will be borne by public spending. The “base scenario” forecasts that consolidated public spending in the period 2010-2012 will stagnate at the nominal annual level of about EUR1,500 million, which will with the mild growth of GDP imply the decrease of its share in GDP by 5 percentage points, from 46.2% in 2010 to 41. 1% in 2012. In this context it should be pointed out that in the pre-crisis year of 2008 the consolidated public spending amounted even to 1,555 million euro, or 50.0% GDP, and in 2009 affected by the crisis it drastically decreased to the level of 1,452 million euro, or 47.1% GDP (see Table 12).

Almost entire burden of adjustment of public finances on the spending side will be in future borne by the current spending, which in 2010 is planned at the lower level than the outturn from 2008. In this way a sustainable functioning of the system of public finances will be ensured through adjustment of the public spending, i.e. reduction of expenditures.

Restraining wage policy is envisaged for the coming period which commenced in 2009. Already in 2009 new employment in the public sector stalled, and such policy will continue in the subsequent period. In addition, in 2010 the public sector payroll system will be centralized, which will contribute to the improvement of transparency and control of spending of funds for these purposes. The amendment of tax rates in 2010 will lead to the reduction of salaries in the public sector within the range 3%-7%.

The new Law on Wages of Lower and Senior-Grade Civil Servants will additionally reduce the wage bill, regulate the employment of new staff, introduce the possibility of more flexible

44

work hours and clearly regulate rights in this area. The Law envisages the possibility of part time employment with wages decreased by 30%. Also, prior to the permanent proclamation of redundancy, the possibility is envisaged for employees to receive 50% wage, without coming to work. Any employees proclaimed as redundant and disbursed severance pays will not be able to be employed in budgetary funded bodies or institutions in the next 5 years. The legal solution clearly defines that it is exclusively the Minister of Finance who signs the decisions on fixed and variable parts of wages. Announcing a public advertisement for a vacancy in a budgetary funded body or institution is preconditioned by the previous approval by the Minister of Finance. The Law abolished additional fees for specific administrative tasks (with the Ministry of Defence, Ministry of Interior Affairs and Public Administration and the like), in the amount of 10% and 30%, which used to be paid in accordance with the previous legal solutions.

According to the budget revision for 2009 and the budget for 2010 the current spending is reduced by around 4% GDP, therefore almost overall amount of the deficit in 2010 is related to the capital expenditures, where current maintenance of road and railway infrastructure was transferred from the capital budget (where it belonged in this year) to the current budget for 2010. In other words, the deficit in the next year will be incurred primarily as the effect of development financing (a range of projects from capital budget). Only 0.28% GDP will be related to current spending financing, while 1% GDP will go for interest financing. This structure of the deficit is a clear evidence of following the “golden rule” in public finances that shortage in the budget should be incurred as a consequence of capital spending financing, and current expenditures should be financed by current revenues.

The side of capital expenditures will also be subject to specific adjustments but in that area the reduction of expenditures will be significantly less robust than the reduction of the current public spending. The share of capital spending in total expenditures will increase, which has already been done in the budget 2010, where the share of capital budget increased by around 5% in relation to the current budget. The capital expenditures as a GDP share will decrease in the period 2010-2012 by only 0.4 percentage points, while in nominal amounts they will grow from EUR233 million in 2010 to EUR253 million in 2012. For capital budget financing in 2010 it is planned to disburse loans mostly from international financial institutions in the amount of around EUR27 million, as well as donations in the amount of around EUR8.3 million. In addition, through the institute of public-private partnership and concession construction in 2010 the amount of around EUR53 million will be provided for capital investments in the area of road infrastructure, as well as around EUR100 million for the construction of the Bar-Boljare highway.

Significant downward adjustments of capital expenditures are anticipated in local self-government capital budgets due to the limited possibility of borrowings and expected fall of all types of communal fees caused by the slowdown in the construction sector. However, it should be pointed out that the Government recognised this restriction of the possibility for the local authorities to borrow and included a range of very important local projects in the central budget, such as waste waters, water supply, roads etc., and even provided the funds from international financial institutions (EIB, EBRD, WB).

The funds from loans, donations and IPA-funds will be used to finance precisely defined expenditures in the budget for 2010 in the total amount of EUR 63 mil or 1.97 % BDP, and in the case these funds are not disbursed, the planned projects will be delayed, i.e. the deficit that is to be financed from the source budgetary revenues will be only somewhat above 2% BDP.

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“Crisis scenario” for the period 2010 – 2012

Unlike the base scenario, the crisis scenario is based on micro-economic projections according to which in 2010 the downward trend of GDP will continue, i.e. the economic growth rate will continue to be negative at the level of -2% (see the upper part of Table 17). The crisis scenario forecasts more rapid recovery of economy for 2011 and beyond. It is necessary to emphasise once again that the crisis scenario could really take place only if all negative trends that are discussed in the sub-section 2.1. take place at the same time. If some of such negative trends took place, then the actual economy performances would be somewhere between the base scenario and the crisis scenario.

A fiscal crisis scenario has also been developed based on macroeconomic indicators, and its basic indicators are presented in the lower part of Table 17.

Table 17: Basic macroeconomic and fiscal indicators of the “crisis scenario” for the period 2010-2012 ( -2 % growth in relation to 2009)

2010 Projection

2011 Projection

2012 Projection

Mac

roec

onom

ic in

dica

tors

Nominal growth of GDP 1.9% 6.1% 7.6%Real growth of GDP -2.0% 3.0% 4.5%Inflation 2,0% 3.0% 3.0%Current account deficit 15.9% 15.9% 16.0%Net foreign direct and other investments 15.9% 16.8% 16.9%Domestic loans 77.7% 76.1% 77.8%Bank deposits 52.6% 54.1% 54.1%

Fisc

al in

dica

tors Public revenues 40.2 40.3 39.4

Consolidated public spending 46.0 43.5 41.1Deficit/Surplus -5.8 -3.2 -1.7Interest 1.04 1.04 1.03Primary Deficit/Surplus -4.8 -2.2 -0.6Public debt level 39.50 38.70 34.20Increase/decrease of deposits -4.28 -2.1 -1.62

Table 18 presents the crisis scenario of Montenegro public finances for the period 2010-2012. The scenario is based on the real GDP growth rate of -2.0% in 2010, 3.0% in 2011 and 4.5% in 2012.

Table 18: “Crisis scenario” of public finances for the period 2010 – 2012

O P I SProjection 2010 Projection 2011 Projection 2012

mil € % GDP mil € % GDP mil € % GDPOWN SOURCE PUBLIC REVENUES 1285.74 40.41 1376.11 42.07 1446.99 41.93Taxes 781.39 24.56 835.45 25.54 873.89 25.32Contributions 307.73 9.67 329.07 10.06 346.39 10.04Duties 30.11 0.95 32.10 0.98 34.54 1.00Fees 110.02 3.46 117.28 3.59 126.19 3.66Other revenues 49.65 1.56 54.92 1.68 58.14 1.68Loan repayment receipts 6.84 0.22 7.30 0.22 7.85 0.23CONSOLIDATED PUBLIC SPENDING 1472.29 46.27 1485.83 45.42 1507.68 43.69CURRENT PUBLIC SPENDING 1246.31 39.17 1249.05 38.19 1254.67 36.36Current expenditures 624.66 19.63 626.84 19.16 611.76 17.73Social security transfers 407.21 12.80 407.77 12.47 427.42 12.39Transfers to institutions, individuals, NGO and public sector 197.44 6.20 197.26 6.03 198.14 5.74

46

CAPITAL EXPENDITURES 225.98 7.10 236.78 7.24 253.01 7.33Borrowings and loans 4.48 0.14 4.52 0.14 4.55 0.13Reserves 12.52 0.39 12.66 0.39 12.80 0.37SURPLUS / DEFICIT -186.55 -5.84 -109.72 -3.25 -60.69 -1.75FINANCING 186.55 5.84 109.72 3.25 60.69 1.75Domestic financing -101.23 -3.18 -77.32 -2.36 -57.34 -1.66Foreign financing 56.66 1.78 38.20 1.17 -12.00 -0.35Donations 20.77 0.65 21.70 0.66 24.90 0.72Revenues from privatization or deposits 73.22 2.30 55.59 1.70 45.59 1.32INCREASE/DECREASE OF DEPOSITS -137.14 -4.31 -71.56 -2.19 -59.55 -1.73

“The crisis scenario” assumes the consolidated public spending at the approximately same nominal level in the period 2010-2012 (due to the lower growth rate in 2010, the nominal amount for 2010 is lower than the one in the base scenario, while for the two subsequent years the nominal amounts are equal). Furthermore, this scenario assumes that in 2010 there will not be any additional reductions of the consolidated public spending despite the economic crisis continuation. While in 2009 it amounted to EUR 1,452 million, “the crisis scenario” forecasts a marginal increase at the level of EUR 1,472 million for 2010.

Since, due to the continuation of GDP retraction in 2010 public revenues in all the years of the period 2010-2012 are lower than those projected in the base scenario (in 2010 by cca EUR 60 to 70 million), this scenario also forecasts a higher level of public finances deficit. From the 4% GDP, as projected for the public finances deficit for 2009, it would according to the “crisis scenario” increase to 5.8% GDP in 2010, and then in the following two years it would begin to decrease to 3.2% GDP in 2011 and 1.7% GDP in 2012. The deficit would be funded from the borrowings from foreign sources and by using the state deposits which would cause the increase of the public debt. In general, after 2010 the fiscal deficit would have to be consolidated in order to bring the public finances back to the sustainable mainstream, taking into account the significance of this system for Euroisedor the year 2010 is assessed as unsustainable, it is realistic to expect that in the case of this scenario it would be necessary to implement additional measures for adjustment of the public finance system in order to insure sustainable functioning of the public finance system. Some of them are as follows:

Implementation of additional saving measures in relation to the current spending (pursuant to Article 5 of the Montenegro Budget Law for 2010); according to the savings generated in 2009 the amount to EUR 20 million is projected for potential savings.

Further reduction of the wage bill, through rationalisation of public administration or reduction of gross wages. There is significant space for reduction, but it is limited by the General Collective Agreement, which was the subject of negotiations with all participants in the social dialogue in Montenegro.

Reduction of discretionary spending – through the reduction of the capital budget of Montenegro. According to the outturns of the previous years it is possible to expect the reduction of the capital budget by EUR 30 million.

Re-examination of tax policy in terms of increase of tax rates in order to increase source revenues of budgets of Montenegro and the local self-government. The increase of the value added tax rate by 1 percentage point would cause additional increase of revenues in the amount of EUR 20 million. Further increase of the fuel excise by 0.05 €/ litre, would lead to the increase of the excise by around EUR 15 million.

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3.1.5 Public Debt Management Strategy

The state debt of Montenegro as of 30 September 2009 amounts to EUR 1.071,2 million or 34.7% (according to the new calculation of the GDP) gross domestic product (GDP). Internal debt amounts to EUR 426.0 million or 13.8% GDP, while external debt amounts to EUR 645.2 million or 20.9% GDP. Guarantees of Montenegro amount to around EUR 83.5 million or 2.7% GDP, i.e. 7.8% of the state debt. The state debt makes around 70.7% of the total generated revenues in 2008 (not including privatisation receipts, loans or donations).

The currency structure of the state debt of Montenegro is favourable: internal debt is in euros, while the part of the total debt which is related to the Paris Club is serviced in other currencies (around 26% of the debt in USD and around 3% in other currencies), as well as the obligations in respect of IDA loans (in SDR). The interest structure is also favourable since around 77% of debt bears fixed interest rates.

The interest rate for external debt ranges from 2% to 5.8%, with the exception of the loans signed in 2008 for the needs of the budget deficit financing that bore interest rates of 8.4% and 9%, while within the internal debt the interest rate of 2% is applied for obligations in respect of restitution and foreign currency savings, and it has already been included in the calculation of the nominal amount of the debt.

Table 19: Montenegro state debt balance as of 30 September 2009, in million Euros

Foreign debt balance

CreditorDebt balance

GDP est

Foreign debt/GDP

% foreign debt

% public debt

(2/3)1 2 3 4 5 6

International Bank for Reconstruction and Development (IBRD) 184.1 3,083.8 6.0% 28.5% 17.2%International Financial Organisation (IFC) 6.9 3,083.8 0.2% 1.1% 0.6%Paris Club Member Countries * 124.4 3,083.8 4.0% 19.3% 11.6%International Development Agency (IDA)** 52.7 3,083.8 1.7% 8.2% 4.9%European Investment Bank (EIB)**** 39.8 3,083.8 1.3% 6.2% 3.7%European Bank for Reconstruction and Development (EBRD) 18.0 3,083.8 0.6% 2.8% 1.7%Council of Europe Development Bank 1.2 3,083.8 0.0% 0.2% 0.1%European Community 5.5 3,083.8 0.2% 0.9% 0.5%Credit Bank for Reconstruction – Germany (KFW) 10.8 3,083.8 0.4% 1.7% 1.0%Austrian Loan 4.1 3,083.8 0.1% 0.6% 0.4%Hungarian Loan 12.2 3,083.8 0.4% 1.9% 1.1%Polish Loan 11.8 3,083.8 0.4% 1.8% 1.1%Societe Generale – Education IT 1.6 3,083.8 0.1% 0.2% 0.1%French Loan*** 8.5 3,083.8 0.3% 1.3% 0.8%EUROFIMA – debt of the Railway Company ***** 22.8 3,083.8 0.7% 3.5% 2.1%Czech EXIM - debt of the Railway Company 45.0 3,083.8 1.5% 7.0% 4.2%Steiermarkische Bank und Sparkassen AG****** 5.5 3,083.8 0.2% 0.9% 0.5%Erste Bank 30.0 3,083.8 1.0% 4.6% 2.8%Credit Suisse Bank 60.3 3,083.8 2.0% 9.3% 5.6%

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TOTAL 645.2 3,083.8 20.9% 100.0% 60.2%* The amount of original debt in euros makes 71%, American dollars 26% and other currencies 3%.**The original amount is in special drawing rights (SDR). The exchange rate XDR/EUR = 1.0724 was used***Commodity loan – EPCG****EIB loans in the total amount of EUR 47.0 million that are serviced by public enterprises (Monteput, Aerodromi CG (Airports of MNE) and EPCG (Energy Company)) are not included in the amount of external debt, but are treated as guarantees.*****The debt to EUROFIMA is CHF 34.5 million, and the exchange rate of 0.6612 was used ******The loan for financing the purchase of fire vehicles for the Ministry of Interior AffairsDomestic debt balance          

CreditorDebt

balanceGDP est

Domestic debt/GDP

% domestic

debt% public

debt(2/3)

1 2 3 4 5 6

Old foreign currency savings 108.53,083.

8 3.5% 25.5% 10.1%

Local self-government debt 61.73,083.

8 2.0% 14.5% 5.8%Obligations in respect of compensations 101.9

3,083.8 3.3% 23.9% 9.5%

Loans with commercial banks 40.93,083.

8 1.3% 9.6% 3.8%Loans with non-financial institutions 7.0

3,083.8 0.2% 1.6% 0.7%

Pensions in arrears 64.43,083.

8 2.1% 15.1% 6.0%

Treasury bills 41.63,083.

8 1.3% 9.8% 3.9%

TOTAL 426.03,083.

8 13.8% 100.0% 39.8%

TOTAL STATE DEBT 1,071.23,083.

8 34.7%Notes:1) The loans from the German KfW bank for the water supply needs are used by municipalities but they are presented in the summary table of foreign debt.

2) Bonds acquired based on the Law on compensation of beneficiaries from pension and disability insurance were issued on 15 September 2008 in the amount of EUR 105 million.

In relation to the end of the third quarter of 2008, the state debt increased by EUR 143.2 million. Internal debt decreased by EUR 27.9 million, while the external debt increased by EUR 171.1 million. Internal debt was reduced by regular payments of debt in respect of old foreign currency savings and restitution, as well as regular payments of debt in respect of extraordinary pensions. In addition, internal debt in relation to the end of the third quarter of last year was reduced by early repayment of old foreign currency saving bonds in the total value of around EUR 0.7 million, as well as early repayment of restitution bonds FO01 and FO02 by the State in the stock exchange, in the total value of around EUR 15 million. The Ministry of Finance plans to continue the redemption of restitution and foreign currency saving bonds in the following year in order to decrease the internal debt.

Growth of external debt is caused by assuming the debt of “Željeznička infrastruktura Crne Gore A.D.” (Railway Company) to the Czech export bank in the amount of EUR 48.1 million,

49

to the European Investment Bank (EIB) in the amount of EUR 7 million (funds have not been disbursed yet), European Bank for Reconstruction and Development (EBRD) in the amount of EUR 11 million (until now 7.8 million have been disbursed), and by assuming the debt of “Željeznički prevoz Crne Gore A.D.” to EUROFIMI in the amount of CHF 34.5 million. In addition, the external debt balance was also increased by the borrowing from Erste Banke in the amount of EUR 30.0 million and Credit Suisse Bank in the amount of EUR 90.0 million (of which around EUR 30.0 million was disbursed by 30 September 2009) for the purpose of budget spending financing.

The mentioned information on the foreign debt balance implies the amounts of engaged (disbursed) loan funds by individual loans. Out of the total available loan funds the following amounts remain undisbursed: around SDR 9.8 million in respect of IDA loan, EUR 28.3 million in respect of KfW loan (water supply phases II and III), around EUR 0.6 million in respect of the EBRD loan for the road rehabilitation project, around EUR 0.3 million in respect of the Polish loan, around EUR 2.8 million in respect of the Hungarian loan, as well as the loans assumed from Željeznica (Railway Company) approved by EIB in the amount of EUR 7.0 million and EBRD in the amount of EUR 3.2 million. Also, in the coming period it is expected that the funds of the commodity loan by the Spanish government for the recycling centre in Podgorica amounting to EUR 6.0 million will be disbursed, as well as the funds of the commodity loan by Erste Bank from Austria in the amount of EUR 6.0 million, the funds of the loan of the International Bank for Reconstruction and Development (IBRD) for the “Cadastre“ project in the amount of EUR 10.6 million, “Energy efficiency“ in the amount of EUR 6.1 million and for the project “Agriculture” in the amount of EUR 11.0 million, the funds of EUR 5.0 million for the waste water project from the European Investment Bank (EIB) loan, the funds of the loan for funding the “Project for procurement of special vehicles for fire extinguishing and rescue” from the Austrian bank Steiermarkisiche Bank und Sparkassen AG in the amount of EUR 16.5 million, the funds of the loan intended for financing the budget spending from Credit Suisse Bank in the amount of EUR 30.0 million. Accordingly, the total amount of available but undisbursed funds is around EUR 142.9 million.

In the first three quarters of the year 2009 the Loan Agreement for financing the “Project for procurement of special vehicles for fire extinguishing and rescue” was signed with the Austrian bank Steiermarkisiche Bank und Sparkassen AG in the amount of EUR 22.0 million, as well as the Loan Agreement with IBRD for financing the Project for institutional development and agriculture strengthening in the amount of EUR 11.0 million, the Loan Agreement for financing of budgetary spending in the amount of EUR 90.0 million with Credit Suisse, the Loan Agreement for financing of budgetary spending in the amount of EUR 30.0 million with Erste Bank, Austria, and the Guarantee Agreement with EBRD for the loan to finance the implementation of the project for the Railway Company, phase III in the amount of EUR 4.0 million.

The Budget Law for 2009 also envisages the signing of the loan with IBRD for the ‘’Project of ecological sensitive tourist areas of Montenegro’’ amounting to EUR 3.75 mil and “Health” amounting to EUR 5.125 mil, with the German Bank for Reconstruction (KfW) for the realization of the Phase IV of the Project for water supply improvement and waste disposal in Montenegrin Coast in the amount of EUR 25.0 mil, with EIB for the projects for wastewater management (EUR 10.0 mil) and waste management (EUR 30.0 mil), with the Council of Europe Bank (CEB) for the project “Solidarity Apartments” amounting to EUR 5.0 mil, with the Government of Austria for the project “Procurement of equipment for oncology clinic” amounting to EUR9.2 mil, and with Hungarian Exim Bank for the project “School Construction in Bar” in the amount of EUR4.0 mil. In addition, it is envisaged that the State should issue guarantees for the following loans: from EBRD for the project Construction of Regional Water Supply in Montenegrin Coast, amounting to EUR3.0 mil and the Railway Project amounting to EUR 7.0 mil, as well as the guarantees for EIB loans for support to the banking sector, in the total amount of EUR 91.0 mil, from KfW for the projects of EPCG

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“Thermal Power Plant Pljevlja I and Sub-station Ribarevina” in the amount of EUR 15.0 mil and “Hydro power plant Piva” amounting to EUR 9.5 mil. Also, the State will sign a guarantee for the regional water supply project with Abu Dhabi Development Fund in the amount of EUR 15.0 mil and guarantees for economy support in the total amount of EUR167.5 mil.

Ministry of Finance deposits as of 30 September 2009 amount to EUR 69.1 mil, including 38,477 ounces of gold, which is by around EUR14.4 mil more than at the end of 2008, while the deposits of state funds, which are not fully integrated in the Treasury system – Pension Fund, Health Insurance Fund and Development Fund of Montenegro, according to the data of the Central Bank of Montenegro amount to EUR48.3 mil, therefore the net amount of the state debt is around 29.4 % GDP. According to the projections of the Ministry of Finance, the state deposits at the end of 2009 will amount to around EUR131 mil (significant increase will follow the recording of revenues from privatisation of EPCG), and when deposits in gold are included, the total amount of state deposits at the end of 2009 will amount around EUR157 mil. The mentioned amount does not include the deposits of the mentioned funds amounting to around EUR 45 mil, since the obligations of funds are approximately the same as the amount of deposits they have available.

The state debt of Montenegro including public enterprises amounts to EUR 1,195.3 mil. or 38.8% GDP. The amount of obligations of state-owned enterprises has been calculated based on the Government guarantees, Central Bank data and data submitted by enterprises.

With regard to repayment of loans, the budget for 2010 plans the repayment of debt in the amount of EUR 61.2 mil and the repayment of liabilities from previous years in the amount of EUR 66.7 mil.

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Table 20: Amount and structure of state debt of Montenegro in the period 2007-2013 (projections for 2009-2013)

  09.2007 09.2008 09.2009.2009.

projection2010

projection2011

projection2012

projection2013

projection

Internal debt (in mil €)

272,4 453,9 426,0 437.2 408.30 354.80 284.70 243.20

Internal debt (% GDP) 10,2 14,6 13,8 14,2 12.8% 10.4% 7.8% 6.1%

External debt (in mil €) 500,6 474,1 645,2 699,5 856.20 964.20 970.00 968.00

External debt (% GDP) 18,7 15,2 20,9 22,7 26.7% 28.3% 26.4% 24.4%

Total debt (in mil €) 773,0 928,0 1.071,2 1136,7 1264.50 1319.00 1254.70 1211.20

Total debt (% GDP) 28,9 29,8 34,7 36,9% 39.5% 38.7% 34.2% 30.5%

Note: Estimated GDP in 2007 – €2,679 mil, in 2008 - €3,115 mil, in 2009 – €3,083.8 mil, in 2010 - €3,201.04 mil, in 2011 - €3,412.3 mil, and in 2012 - €3,671.6 mil, in 2013 – 3,965.4 - Source: Ministry of Finance

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Table 20 presents the projected amount of state debt, based on assumed legal and contractual obligations of the State, for the purpose of estimating the debt sustainability. The projection of internal debt trends in the period 2009 to 2012 as stated in Table 19 is based on the assumptions that the debt in respect of restitution will reach the level of EUR 350.0 mil by 2012, while the repayment in this respect will amount to around 0.5% GDP on annual basis. The amount of repayment of liabilities in respect of pensions in arrears will be EUR 34.0 mil annually and will be fully repaid by the end 2011. New borrowings are envisaged in 2009 intended to finance the projects of the Transport Directorate, to resolve transport bottlenecks, in the total amount of around EUR 32 mil. The assumption is that the amount of local self-government debt will remain on the current level. The repayment of liabilities in respect of foreign currency savings will amount around EUR 14.0 mil annually. The redemption of foreign currency savings bonds OB16 and OB17 and DO16 and DO7 has not been taken into account, or the redemption of restitution bonds. In addition, it is assumed that there will be no assuming of debts of enterprises.

When projecting foreign debt, new borrowings and on-lending have been projected in accordance with the agreed framework of cooperation with international and bilateral creditors, and the funds will be used for projects from the area of waste waters, regional water supply, road and railway infrastructure and energy. The trends of foreign debt have been projected with the assumption of average four-year disbursements of loan funds in the amount of EUR 50 million (in 2010), and EUR60 million (in 2011 and 2012). In 2009, the borrowing amounting to EUR 200.0 mil. has been added for financing of budget deficit and repayment of loans, in 2010 additional EUR 200.0 mil and in 2011 additional EUR100.0 mil.

With regard to the borrowings for the needs of budget financing, alternatives, i.e. concurrent borrowings with the following institutions are considered: International Monetary Fund, World Bank (Development Policy Loan – to US$ 85 million), European Commission, bilateral creditors, i.e. through Eurobond issue. The borrowing conditions will be considered during the negotiations with the representatives of the mentioned institutions, and based on the most favourable conditions, credit arrangements will be concluded with one of the mentioned institutions.

In 2010 it is planned that the State borrows: from IBRD in the amount of EUR 3.5 mil. for financing of the ‘’Project for ecological sensitive tourist areas of Montenegro”, from the CEB for financing of the project ”Solidarity apartments and resolving of housing needs of citizens and mitigation of economic crisis effects on the construction sector“ in the amount of EUR10.0 mil, from EBRD in the amount of EUR30.0 mil (stand-by loan funds) for the needs of the Deposit Insurance Fund, from EIB in the amount of EUR 25.0 mil for financing of the wastewater management project and EUR 5.0 mil for the project ”Resolving of transport bottlenecks“.

Also, it is planned to sign bilateral and multilateral loans intended for the need to protect monuments of culture in the amount of EUR 5.0 mil. In addition to the mentioned, the budget 2010 plans the borrowings for providing funds for budget financing, repayment of debt and support to the banking system in the amount to EUR 200.0 mil. With regard to State guarantees, it is planned to issue guarantees in the total amount of EUR 202.0 mil, out of which EUR 140.0 mil relates to guarantees for agriculture support loans, EUR15.0 mil for the loan for the Railway from EBRD, EUR7.0 mil for the loan for the Railway from EIB, as well as EUR 40.0 mil for the loan for purchase of new ships from the Chinese Export Bank, the beneficiary of which is ‘Crnogorska plovidba AD Kotor’.

In 2010, it is planned to commence the development of a new Debt Management Strategy. The mentioned strategy will define new borrowings projections as well as the amount, and debt repayment schedule, which will be required to be done in particular after the change of the situation in the economic area caused by the world economic crisis.

State debt under “crisis scenario” conditionsThe starting assumptions for projection of the state debt under crisis scenario conditions are as follows:

Budget source revenues will be additionally reduced according to the crisis scenario projection of public finances for the period 2010 – 2012, presented in Table 18 of the section 3.1.4. Mid-term fiscal framework for the period 2010 – 2012

Privatisation receipts and receipts in respect of property sale in the period 2010 – 2012 will not be achieved, which will imply additional foreign borrowings for the needs of budget financing, which will increase the overall public debt.

Based on non-generated privatisation receipts, the need for borrowings for budget financing will increase, in the following amounts:

o in 2010 – 59 million euro, o in 2011 – 45 million euro, o in 2012 – 33 million euro

In the period 2010 – 2012, liabilities will not incur in respect of issued guarantees. Companies that have been issued guarantees for borrowings, whose repayments have already commenced or are commencing in the observed period, have been regularly settling their obligations so far. Guarantees have been issued to the following enterprises: EPCG (Energy Company of Montenegro), Aerodromi Crne Gore (Airports of Montenegro), JP Regionalni Vodovod (Regional Water Supply), as well as Montenegrin commercial banks for loan support to small and medium size enterprises. Based on the analysis of the position of specific economic branches and balances of the very companies, the assumption is that these companies will continue to settle their obligations on regular bases.

The following tables present fiscal indicators and state debt indicators depending on fiscal scenarios.

Table 21: Basic fiscal indicators and state debt indicators - Base scenarioIndicators 2010 2011 2012Public revenues 41.89% 42.06% 41.1%Consolidated public spending 46.0% 43.5% 41.1%Deficit/Surplus -4.1% -1.5% 0.0%Interest 1.0% 1.0% 1.0%Primary Deficit/Surplus -3.1% -0.4% 1.1%State debt level 39.5% 38.7% 34.2%Increase/decrease of deposits -2.6% -0.4% 0.1%

Table 22: Basic fiscal indicators and state debt indicators - Crisis scenarioIndicators 2010 2011 2012Public revenues 40.17% 40.33% 39.41%

Consolidated public spending 46.0% 43.5% 41.1%

Deficit/Surplus -5.8% -3.2% -1.7%

Interest 1.04% 1.04% 1.03%

Primary Deficit/Surplus -4.8% -2.2% -0.6%

Public debt level 42.9% 44.9% 42.5%

Increase/decrease of deposits -4.28% -2.1% -1.62%

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Table 23: Amount of state debt in 2008 and 2009 and projections for the period 2010 – 2012, based on base and crisis scenarios

 

2008 2009 Projection 2010 Projection 2011 Projection 2012 Projection

Mil.Eur GDP% Mil.Eur GDP% Mil.Eur GDP% Mil.Eur GDP% Mil.Eur GDP%Total state debt

Base scenario 894.7 29.0 1,136.7 36.9 1,264.5 39.5 1,319.0 38.7 1,254.7 34.2

Crisis scenario         1,372.4 42.9 1,530.8 44.9 1,561.7 42.5Foreign state debt

Base scenario 481.7 15.6 699.5 22.7 856.2 26.7 964.2 28.3 970.0 26.4

Crisis scenario         963.8 30.1 1,176.0 34.5 1,277.0 34.8Domestic state debtBase scenario 413.0 13.4 440.6 14.3 408.6 12.8 354.8 10.4 284.7 7.8

Crisis scenario         408.6 12.8 354.8 10.4 284.7 7.8

As it can be seen from the Table, in the situation of crisis scenario, the total state debt reaches the maximum share in GDP of 44.9% in 2011, which is by 6.2 percentage points less than its amount in the base scenario. This difference in the amount of state debt is even greater in 2012 (8.3 percentage points) due to significantly lesser reduction of the state debt in the situation of the crisis scenario.

3.1.6 Budget implications of main structural reforms

Privatisation process continuation. Receipts of the budget of Montenegro and budgets of state funds and the sale of property in 2009 are planned in the amount of EUR 35 million. When planning this revenue for 2009, additional capitalization and partial privatisation of EPCG were not taken into consideration. In this respect, the privatisation receipts amount over EUR90 million. According to the Montenegro Budget Plan for 2010, the receipts from the sale of property are planned in the amount of EUR59.00 million and will be used for financing of capital budget and budget deficit. The planned amount of receipts in respect of the sale of military property amounts to EUR2 million, and the remainder is related to the revenue from the planned sale of shares that the State owns in the following enterprises: Institut Simo Milošević – Igalo – EUR20 million, Luka Bar -Port of Bar (AD Kontejnerski terminali i generalni tereti – Container Terminals and General Cargo) – EUR26 million and AD Montecargo – EUR 11 million.

Reduction of tax burden on wages. Despite the negative global crisis effects, and weaker outturn of the revenues of the Montenegro budget and local self-government budgets, the policy of low tax rates continues in 2010 for the purpose of eliminating business barriers and attracting investments. The practise evidenced positive effects of such fiscal policy. In 2010 there will be further reduction of the burden for employers since the contribution rates paid by employers from gross salaries will be reduced from the current 14% to 10% in 2010. The estimated effect on the Montenegro budget in 2010, i.e. on the state as an employer, is around EUR 14 million less contributions paid by employers and as much lower gross wages.

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Improvement of road infrastructure and road transport. Montenegro Budget Law for 2010 envisages significant funds for the Montenegro Capital Budget in the total amount of EUR 121 million, which makes almost 4% GDP. The significance of capital expenditures in the Montenegro budget, for 2010 and in years to follow, lies in the awareness of the fact that elimination of infrastructure bottlenecks, primarily in the physical infrastructure, facilitates for growth of economy, standard of living of citizens, and strengthens the capacities of the country for implementation of EU standards. This highlights the need for further intensification of the function for identification of credible budget-funded capital projects and demonstration of permanent commitment and ability for servicing obligations in respect of debt so Montenegro would be awarded the investment credit rating and become an attractive investment destination in the international market. As it can be seen from the Table 24, out of the total amount, the funds amounting to EUR 57.95 million are planned for the Transport Directorate, and they are related to improvement of road infrastructure. The following table presents projects to be implemented in 2010 through the Transport Directorate:

Table 24: Capital budget of the Directorate for Transport for 2010Description Amount

Total 57.950.000,00Road Risan – Grahovo – Nikšić- Žabljak 2.500.000,00

Producing of the project for Adriatic-Ionic highway 1.000.000,00Resolving of bottlenecks in the transport network of Montenegro 7.850.000,00Third lanes of highways 1.000.000,00Reconstruction of regional roads and highways in Montenegro 8.500.000,00Rehabilitation of tunnels on highways and regional roads 1.000.000,00Investment coating of highways and regional roads 1.000.000,00Expropriation of land for construction of the highway Bar-Boljari, section from Smokovac to Verušae 4.000.000,00Construction of the overpass in Bar 600.000,00 Program for reconstruction of intersections 2.500.000,00Rehabilitation of slides 1.000.000,00Rehabilitation of the road base of the highway Ribarevine – Berane 1.000.000,00Ring road Rožaje 1.000.000,00Construction of the Bar – Boljari highway 25.000.000,0

0Employment policy and amendments to the regulations related to labour market. Since January 2009 the Law on Employment and Labour of Foreigners has been in force, and three secondary legislation acts were adopted based on them, which clearly prescribe procedures and systematically adjusted employment of foreigners in Montenegro. Net positive effect on the budget of Montenegro in respect of new regulations in 2009 has been estimated to EUR 18 million based on the estimate that 40,000 work permits for residents will be issued. However, due to the impact of economic crisis, the number of non-residents employed in Montenegro and budgetary revenues are significantly lower. By the end of October 2009, around 16.600 work permits were issued to non-residents. For the next year it is difficult to envisage the number of non-residents that are to work in Montenegro, for two basic reasons. The first one is that a significant number of non-residents was employed in the construction sector, which is heavily hit by the crisis, and the recovery in 2010 is uncertain. On the other hand, the planned dynamics of the construction of the Bar-Boljare highway and the commencement of works in Luštica, might significantly increase the number of non-resident workforce in the following year.

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3.2 Public finances quality

In 2009, amendments to legal framework were adopted as well as initiated that in 2010 are to lead to changes on the side of current budgetary revenues. Excise on mineral oils and excise on tobacco and tobacco goods were increased. The lowering of the personal income tax and the Amendments to the Law on Compulsory Social Insurance are the measures that will lead to further reduction of burden of employers for the purpose of creating the most favourable environment for development of business. Tax rates defined by the Law on tax on use of passenger motor vehicles, watercrafts and aircrafts have also been amended.

Tax rates have been significantly amended according to the Amendments of the Law on Personal Income Tax and Amendments to the Law on Contributions for Compulsory Social Insurance. The following table presents the current and amended tax rates:

Table 25: Amended tax rates and rates of contributions on wages DESCRIPTION 2009 2010Personal income tax 12% 9%Non-taxable part of the wage (monthly) 70 € 0 €Total contributions paid by employers 14.5% 9.80%Total contributions paid by employees 17.5% 24.0%Total contributions for compulsory pension insurance 20.5% 20.5%Total contributions for compulsory health insurance 10.5% 12.3%Total contributions for insurance against unemployment 1.0% 1.0%Total contributions for compulsory social insurance 32.0% 33.8%

As previously mentioned, in 2009 the structure of source revenues changed in relation to previous years. The growth of revenues from direct taxes (income tax and social contributions) in the total revenues from taxes is notable, while the share of revenues from indirect taxes concurrently decreased (40%:60% in favour of direct taxes). In 2009, the growth of wages and increase of employment continued which led to the increase of revenues from direct taxes, while the revenues from value added tax on imported goods and tax on foreign trade and transactions decreased. In the previous years, due to a high share of VAT on imported goods, the structure of total collected VAT was 75:25 – VAT on imported goods : VAT in internal trade, while in this year, primarily due to the decrease of VAT on imported goods, this ratio changed to 63:37 and such trend may be expected in 2010 and the following years.

Monitoring of basic indicators of economic activities was introduced in the course of planning of the revenue side, where 20 indicators from four areas are monitored, based on which the projections of GDP trends are produced. Also, detailed analyses were produced in the attempt to distinguish cyclical from structural revenues of Montenegrin economy, and the projection of revenues for 2010 was produced based on structural revenues.

Since 2008, five extra-budgetary funds have become state funds and planned as an integral part of the budget of Montenegro. In the period 2008-2009, the Employment Fund and Compensation Fund were integrated in the system of State Treasury and their receipts and expenditures are recorded through the Consolidated Treasury Account. Other funds functioned independently in practice. In 2010, the Fund for Health Insurance and Fund for Pension and Disability Insurance will be included in the system of State Treasury which will provide for better transparency, as well as control in execution of expenditures.

The adoption of the Law on Wages of Lower and Senior-Grade Civil Servants and robust control of new employment initiated the restraining of the wage bill growth and the

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centralization of the payment of wages of all budgetary beneficiaries is in process. Another important change that will impact the quality and transparency of public finances is related to the change in presentation of expenditures by economic classification with a part of budgetary beneficiaries. Namely, gross wages, capital expenditures, expenditures for material and services and other expenditures have not been presented within transfers. In the Budget of Montenegro for 2010, all transfers except for the Health Insurance Fund are presented by economic classification, while in the next year it will be worked on the centralization of all revenues of budgetary beneficiaries, primarily public institutions, which will contribute to realistic viewing of budgetary needs of these spending units.

In 2009, based on the provisions of Organic Budget Law, the Ministry of Finance issues opinions on the budgets of local self-governments, which in practice will improve the control of public expenditure growth and assist to balancing of overall public spending.

According to the provisions of the Law on Budget Revision for 2009 all spending units are obliged to obtain approval from the Ministry of Finance prior to public contracting, which additionally established the control over spending of budgetary funds and reduced the possibility of carrying forward liabilities to following years.

Given that 2010 will be significantly different from previous years for which Economic and Fiscal Program was produced, our view is that it is important to mention once again all the factors that will impact the improvement of the quality of public finances in 2010 and mid-term framework:

Defining of “fiscal anchors“ for mid-term framework Including of all state funds in the State Treasury system Re-examining of employment and wage policy Central calculation and recording of wages (centralised payroll system) Recording of transfers by economic classification Completion of tax reforms Continuation of privatisation process Elimination of business barriers

3.3 Public finances institutional framework

The commitments of Montenegro to international organizations, primarily undertaken in the process of integration in the European Union require the establishment of new institutions that will have the status of spending units within the budget of Montenegro. Under the conditions of economic crisis and necessary rationalisation of budgetary expenditures, it will be taken into account to the maximum extent that the establishment of new institutions should not contribute to the increase of current spending. In this context, the premises for accommodation of new institutions will be provided within the premises already in use by public institutions, and the administration of newly founded institutions will be provided by taking over employees from line ministries and other state institutions. The Montenegro Law on Budget for 2010 envisages the establishment of the following institutions:

Under the Ministry of Economy:o Administration for Hydrocarbons o Mining Administration

Under the Ministry of Maritime Affairs and Transport:o Directorate for Railwayso Port Administration

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Under the Ministry of Labour and Social Care:o Labour Fundo Agency for amicable resolution of labour disputes

Under the Ministry for Protection of Minorities and Human Rights:o Centre for development and preservation of minorities in Montenegro

Development Fund, that had the status of an extra-budgetary fund by 2008, and in the period 2008-2009 the status of a state fund, from 2010 will not be planned as an integral part of the budget of Montenegro, but will be transformed in the Investment Development Fund of Montenegro and will be a joint stock company under the ownership of the state of Montenegro. Taking into account the significant changes in Montenegrin economy (in the part related to banking sector, capital market, priorities and needs of economic development, overall economic environment, legal regulation) a need emerged to transform the Fund and adjust its objectives to further economic development and economic policy of the Government of Montenegro. Also, significant reasons for transformation arise from the current position of the Development Fund which is characterised by non-harmonisation of the regulatory framework (SAI recommendations, need for adjustment to the Law on Business Organizations in terms of the business organization form, disability to apply corresponding regulations treating financial reporting, inadequate organisational structure and the like). Newly established entity will have the following goals which will represent the base for further development of economy:

1. Support to implementation of infrastructure and environmental projects 2. Balancing of regional development 3. Support to the sector of micro, small and medium size enterprises 4. Carrying out of privatisation of the remainder capital in the portfolio of the Fund 5. Generating receipts from to-date placements.

4. STRUCTURAL REFORMS OBJECTIVES

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4.1. Enterprise Sector

4.1.1. Privatisation

Intensive and successful implementation of activities in the privatisation area had a positive impact on generating new economic structures, new ways of thinking, growth and the overall development of Montenegrin economy in the long run. The negative aspects of privatisation are largely a consequence of uncleared property relations and delays in adoption and implementation of the laws that regulate those relations.10

In 2009 the Agency for Economic Restructuring was shut down, and Privatisation Council except the conceptual role in the privatisation process, took over the conduct of technical and administrative activities. Year 2009 was marked by success of the biggest privatisation process in Montenegro – „Elektroptivreda Crne Gore“ (the Electric Power Industry of Montenegro) – on one side, and in terms of crisis, a series of unsuccessfully completed tenders on the other side. Recapitalisation of Electric Power Industry of Montenegro is the largest privatisation project in Montenegro, both in financial and in terms of multiplicative effects on the economy.

In addition to the sale of the minority package of shares of the insurance company „Lovćen osiguranje” to the current majority owner „Triglav osiguranje“ from Slovenia, other privatisation processes which have started in 2008, were not realised due to lack of interest of investors. Therefore, tenders were unsuccessfully completed for the privatisation of the Institute „Dr Simo Milošević“ Igalo, „Jadransko brodogradilište“ AD11 Bijela, dairy „Zora“ Berane, public press publishing and printing company „Pobjeda“ AD Podgorica, HTP „Ulcinjska rivijera“ AD Ulcinj and „Duvanski kombinat“ AD Podgorica. Some of the initiated privatisation processes of companies such as electric industry „Obod“ AD Cetinje and „Duvankomerc“ DOO12 Podgorica during 2009 were completed by bankruptcy. Some of the projects of tourist valorisation of attractive tourist sites have been successfully completed (Luštica I and II), while „Mediteranski centar“ Žabljak, „Velika plaža“ and „Ada“ were finished with a lack of interest of investors for investment.

The main privatisation objectives in 2010 are continued increase of competitiveness and efficiency of companies in Montenegro, encouragement of foreign investments and entrepreneurship in all areas, increase of employment and improvement of the standard of living. Privatisation in 201013 will be marked by capitalisation of the national airlines company Montenegro Airlines and valorisation of tourist sites which will define the concept of development of tourist infrastructure in the coastal area of Montenegro. Mild recovery of world economy also carries the expectations that the failed privatisation projects during 2009 will end successfully in 2010. Specific projects for 2010 are as follows:

- Restructuring of the company „Željeznice Crne Gore“ (Montenegro Railways) AD Podgorica led to the formation of two companies: Rail infrastructure and Rail transport „Montecargo“. Tender for the sale of 85.4% of the shares of Railway transport has been announced until February 2010.

10 More in the Analysis of the privatisation effects in Montenegro, Podgorica, Faculty of Economics (December 2008).11 Joint stock company

12 Limited liability company

13 Privatisation plan for 2010 (Council for Privatisation) defines a list of companies that will be privatised by the various methods during 2010.

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- The company „Luka Bar“ AD Bar is restructured into two companies: Holding „Luka Bar“ AD Bar with 100% ownership of limited liability companies „Obezbjeđenje i protivpožarna zaštita Bar“ (Security and Fire Protection Bar) and „Informatika i komunikacije Bar“ (Information and Communications Bar) and „Kontejnerski terminal i generalni tereti Bar“ AD (Container Terminal and General Charges Bar – joint stock company). Tender for the privatisation of 54% of the company „Kontejnerski terminal i generalni tereti Bar“ AD has been announced as well as for awarding concession period of 30 years with the obligation of investing, which will be also open to offers until February 2010.

- In 2010 through an international public tender, procedure of choosing investors for valorisation of tourist sites will be implemented: Ada Bojana, Velika plaža, Njivice, Utjeha, Buljarica i Jaz and continue the evaluation of the activities of the military-tourist complex „Mediteran“, Žabljak , "Bigovo – Trašte", Kotor barrack ’’Orjenski bataljon’’ Kumbor, island of Mamula – Herceg Novi, barrack ’’Radoje Dakić’’ Žabljak and „Valdanos“ – Ulcinj.

- Tenders have been announced for the privatisation of the company „Montepranzo-Bokaprodukt“ AD Tivat and „Marina“ AD Bar which are expected to be finalised in the first half of the 2010.

On the basis of a decision passed by the Privatisation Council, the preparation of tenders for the following companies will continue:- In the field of transport: „Željeznička infrastruktura Crne Gore“ AD Podgorica, „Barska plovidba“ Bar; - In manufacturing sector: Jadransko brodogradilište“ (Adriatic Shipyard) AD Bijela, "Zora" AD Berane, „Duvanski kombinat“ AD Podgorica, „Institut crne metalurgije“ (Institute of ferrous metallurgy) AD Niksic;- In the field of tourism: the Institute „Dr. Simo Milošević“ AD Igalo, HTP „Budvanska rivijera“ AD Budva, HTP „Ulcinjska rivijera“ AD Ulcinj; - In energy sector: "Montenegro bonus" DOO Cetinje, „Elektroprivreda Crne Gore“ AD Niksic - small hydroelectric power stations and- In the field of newspaper printing and publishing activities: „Pobjeda“ AD Podgorica.The privatisation process for „Pošta Crne Gore“ (Mail Montenegro) DOO Podgorica will also be initiated.

Projected recovery of the world economy in 2010 also means the revival of investment activities. The attractiveness of potentials of countries in transition, including Montenegro, could represent a good basis for investment expectations, and therefore the success of privatisation of remaining projects.

Privatisation in 2010 will be focused on projects in tourism and transportation sector. These projects in the country, in which is situated one of the most important ports for the region and whose priority is the development of tourism industry, can further increase the interest of investors. On the other hand, the consequences of the crisis have left traces on all actors in the economy, which has been taken into account with regards to the projection of revenues from privatisation.

4.1.2. Competition, state aid and public procurement

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4.1.2.1 Competition

Implementation of competition policy is the responsibility of the Administration for Competition Protection as an independent operating body for the protection of competition. Objectives, priorities and implementation strategies are defined by the Strategy on competition policy from 2008. The ultimate goal is achievement of complete harmonisation of competition and national legislation with the acquis and effective implementation of these policies through functionality of independent competent bodies. Economic and Fiscal Programme for Montenegro 2008-2011 announced the adoption of the new Law on Protection of Competition in the second quarter of 2009. Law provides the establishment of the Agency for Competition Protection, its status, authority and funding. Due to commitments to introduce specific changes with regards to the conduct of the proceedings before the future Agency for Competition Protection, which must be fully compliant with EU regulations, the adoption of the new Law has been postponed for the first quarter of 2010. With the establishment of the Agency for Competition Protection, Administration for Competition Protection will cease operations.

Three years of experience in functioning of the Administration for Competition Protection proved the following limiting factors of its development: (i) an insufficient number of qualified personnel, which could guarantee the smooth functioning of the Administration, greatly hindered by the impossibility of planning to increase the number of employees and dispersal of existing staff, (ii) in addition to improvement of legislation, it is necessary to strengthen human resources in specific areas with regards to law application, such as telecommunications, media, financial services and others., (iii) lack of financial resources intended for the operations of the Administration for Competition Protection. However, confirmation that the implementation of the Law on Competition Protection has begun, is the number of submitted requests for issuance of approval for conduction of concentration (46), out of which in 90% of cases the claimant was a foreign investor. This leads us to conclusion that the situation in Montenegro is favourable for foreign investors, and they have the same treatment as domestic investors in our market.

It is anticipated that after the adoption of the new Law on Competition Protection in the first quarter of 2010, within next half a year the appropriate bylaws will be adopted, which will complete the legal framework in this field. The Agency will in the future, in addition to control of concentration and non-operative actions in order to achieve a higher degree of competition culture, organisation of seminars, training and round tables (Competition Advocacy), pay particular attention to: (i) evaluation of work, analysis of resolved cases (temporal and quantitative analysis) with the necessary recommendations for improvement, in order to achieve greater efficiency, (ii) training of judges and employees in sectoral regulators, (iii) providing conditions for the detection of violations of competition rules, particularly with regards to tacit agreements and abuse of dominant position, where those conditions will be ensured by introduction of „Leniency Programme“ (determining violations of competition rights - jurisdiction of the EC).

Fiscal effects of competition policy. Planned direct budgetary expenditures associated with the Agency for Competition Protection and implementation of the new Law amount € 159,344.65 in 2009, € 304,367 in 2010, € 319,585.35 in 2011 and € 329,172.91 in 2012.

4.1.2.2 State Aid

Challenges regarding the introduction and implementation of state aid system in Montenegro are resulting from the complexity of regulation of state aid in general, as well as from the fact that this is a new area which in the future should continue to build. In this regard, in 2009

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was prepared a new set of regulations in collaboration with experts from the EU, namely: (i) Law on State Aid Control (Official Gazette of Montenegro, No. 74/09) (ii) Regulation on acceptable costs, the maximum intensity of state aid and other criteria that are applicable for the allocation of state aid for certain state aid goals; (iii) Regulation on methodology and notification submission form and control of state aid, and (iv) Regulation on the annual report content with regards to the allocation of state aid, which is mostly compliant with the acquis and the Treaty establishing the EC.

Solutions contained in a Draft Law on State Aid Control will contribute to the further development of a transparent state aid system. This is particularly true with regards to the obligation of the Commission for the control of state support and assistance to prepare a unified list of regulations on the basis on which were made allocations or on which state aid is allocated. Commission is obliged to submit unified list with proposed measures to the Government in order to comply with the solutions from the Law ( Article 26 of Draft Law on State Aid Control). The specified solution will allow efficient previous (ex ante) and subsequent (ex post) control of all new state aid measures, as well as harmonisation of existing measures with rules that will be established, which will have positive effects in the creation of economic policy, rational budget planning and management of appropriate policy of regional development.

State aid measures disturb competition and cause real discrimination between market participants (companies that receive and those which do not receive state aid), and therefore adoption of regulations governing this area has established a system accepting that the allocation of state aid, although incompatible with the common market, may be justified in exceptional circumstances. This has created conditions for respecting the rights of the single market and the preservation of competition between economic entities.

According to the annual report on the assigned state aid, in Montenegro in 2008 was allocated state aid amounting to 45.896 million euros, which is 1.37% of GDP, and is significantly higher than the 24.847 million euros in 2007. Percentage of state aid of GDP without transportation and agriculture sectors in 2008 amounted to 1.2%. Comparing the structure of state aid allocated in 2007 and 2008 shows a negative trend that is reflected, above all in reduction of the share of horizontal state aid in total allocated state aid, given that, precisely, this category of aid, at a minimum causes disorders of competition in the market. In total allocated state aid in 2008, noticable is significant increase of public sector aid (112.46%). Noted increase is conditioned by the allocation of the state aid to the banking system in order to reduce the consequences of the global financial crisis. The increase of this aid category is also evident in the steel and agriculture sectors.

TABLE 26: Structure of the allocated state aid Aid typeYear horizontal sectoral regional

2007 59.48% 40.52% 0.0%

2008 4.93% 46.60% 48.47%

In the future period, priorities of state aid policy should go towards development of regional aid map based on NUTS II system, reducing the participation of sectoral aid in the total amount of allocated state aid and diversion of state aid funds from social goals towards well-prepared projects, or towards horizontal objectives such as investments in small and medium size enterprises, research and development, employment, training of employees and environmental protection.

4.1.2.3 Public Procurement

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In Montenegro in 2008, 5504 public procurement contracts were concluded (without immediate agreement - the value of procurement up to 2000 euros), in the total amount of 537,996,900.38 euros, or 16.11% of total GDP. This is significantly higher than in 2007, when the value of public procurement amounted to 411,992,511.45 euros or 18.92% of GDP. In 2008, in open public procurement procedures contracted procurements amounted to 387,278,406.21 euros, or 71.99%, while in other cases 150,718,494.10 euros, or 28.01%. According to the World Bank standards, transparency principle in public procurement in Montenegro is at the highest level (over 71% of procedures was conducted by applying an open public procurement procedure). In public tender procedures there was a total of 4655 submitted offers or 3.03 offers per one procedure, which ensures the principle of competitiveness. Principles of economy and efficiency savings were achieved through savings of public funds of 31,575,259.04 euros, as the difference between the estimated and the contracted value.

The Commission for the control of public procurement in 2008 and 2009 implemented a series of activities to improve public procurement system and its promotion. First, in the period from 01/01/2009 until 01/11/2009, the Commission passed decisions on 227 complaints, of which 71 was adopted. In cooperation with the World Bank, the Commission issued a publication „Protection of bidders rights in public procurement in Montenegro“. The Commission has also started a comprehensive PR campaign, in which has organised a series of press conferences. In cooperation with the European Commission Delegation in Montenegro, the Commission has developed web portal www.kontrola-nabavki.me, which has helped improve the public procurement system. The site continuously after each session, publishes all decisions based on submitted appeals. Starting from the fact that, establishing the portal-www.kontrola nabavki.me significantly increased the number of submitted complaints, proves a greater degree of knowledge of the system with regards to protection of rights in public procurement procedures by the bidders and a higher quality of complaints content and reference to previous decisions made by State Commission, we conclude that the protection rights system in public procurement procedures has a positive impact on the business environment, as domestic and foreign companies are familiar with procedures and the way that those rights can be protected and exercised.

The Commission had intensive regional and international cooperation. With the support of UNDP it organised workshop for employees as well as members of the Commission. Activities on the implementation of the National Integration Programme and innovative Action Plan on implementation of programs to fight corruption and organised crime, as well as implementation of obligations under Enhanced Permanent Dialogue with representatives of the European Commission are continuously monitored.

Preparation of technical basis to change the legislation in public procurement area was completed in December 2009, after which started preparations with regards to the drafting of legislative solutions in this area, in order to have further harmonisation with the relevant directives and requirements of the European Court of Justice. In this sense, the legal text will be put in the procedure of passing in the fourth quarter of 2010. This activity will be conducted in collaboration of Public Procurement Directorate with the Ministry of Finance and the Commission for the control of public procurement.

In the next 18 months public procurement policy will be supported by the project IPA 2007, which began with the implementation on the 27th May 2009. Implementation participants involve the Directorate of Public Procurement, as the beneficiary, and partners in the project, Ministry of Finance and the Commission for the control of public procurement. Implementation of this project will focus on improvement of regulations in public procurement (Law and Bylaws), the national training system in this area, strengthening the capacity of the Directorate for public procurement, modernisation of the system of publication of notices on public procurement, spread of national awareness about the importance of a healthy and

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robust system of public procurement, the adoption of strategic studies for the introduction of e-procurement in Montenegro, establishment of a platform for electronic public procurement, the adoption of the Strategy for development of public procurement 2010-2014.

In accordance with the assessment of the European Commission, presented in the Progress Report for Montenegro for 2009, that it was necessary to strengthen the capacity building of the Directorate of Public Procurement and the Commission for the control of public procurement, a request for approval of budget funds was submitted in the amount of 298,507.50 euros + 50,000 euros (for the IPA project) for the Directorate of Public Procurement and 379,619.50 euros for the Commission for the control of public procurement.

Commission for the control of public procurement is in the negotiations process with UNDP in preparing a project proposal which has the value of 50,000.00 euros, and is in the process of adopting a new Regulation on the systematisation of professional services of the Commission for the control of public procurement, by which new working places will be systematised, and will comply with explicit requirements for strengthening the administrative capacities of this institution.

4.1.3. Business environment including tax aspect

Support to SME sector

Creation of the conditions for entrepreneurship and SME development remains one of the priorities of Government of Montenegro economic policy. Small and Medium Enterprises Development Strategy 2007 – 2010 defines strategic framework of the objectives and tasks for the creation of a stable and simulative environment for growth and development of SME sector and intensifying entrepreneurship.

Abovementioned Strategy, inter alia, prescribes that by the end of 2010 comparing to 2006 following objectives should be achieved:

- Increase of the number of new SME and entrepreneurs for 30%. By the end of 2008 number of SME amounted to 15.35714 which represents the increase of 33,28% in comparison 2006 (11 522);

- Increase of the employment in the SME sector for 20%. Number of the employees in SME sector has increased from 85.065 in 2006 to 104.544 in 2008, which represent the increase of 22,89%. This led to increase of the ratio of number of employees in SME sector and total number of employees from 56,41% in 2006 to 62,90% in 2008;

- Increase of the participation of SME in total export on 30%15 (competitiveness, internationalization). Participation of SME in total export at the end of 2005 amounted to 22.23%16;

- Increase of the share of SME in GDP to 60%17.

14 Source: Tax Administration 31. 12. 2008. of which micro firms amounted to 11.852, entrepreneurs 1.609, small 1.472 and medium enterprises 424

15 There are no official statistics on SME share in total export in 2006, 2007, 2008

16 Data are taken from the Annual Report of Chief Economist of the Central Bank of Montenegro 2002 – 2005. For more details, see document SME Development Strategy 2007 – 2010 – Analyses of the SME share in export 2002 – 2005.

17 Monstat Estimation on SME share in GDP in 2003 – 58,79%. There is no official statistic on SME share in GDP after 2003.

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Abovementioned data indicate to the increase of the number of employees in SME sector as well as the real expectation that by the end of 2010 share of SME in the total export will achieve estimations defines by the Small and Medium Enterprises Development Strategy 2007 – 2010.

Implemented active policy measures for enhancing SME development

SME sector is funded by the credit lines of the Directorate for Development of SME, the Development Fund and the Employment Agency. In the first nine months of 2009 these three institutions approved 695 projects in the total value of 17,111,701.00 € by which 1.448 new working places have been created. In the same period of time the Directorate for Development of SME approved 16 application in the value of 54,431.18 € for Grant schemes with purpose to support market participation, cover marketing activity costs and improve companies possibilities for more successful business performance (introduction of new technologies, market research etc). Projects IPA Cross Border Cooperation and Adriatic Programme of Cooperation in the area of SME development have been nominated, under the programs which are funded by EU funds.

Under the institutional support to SME, activities have been undertaken regarding the reorganization and improving capacities of the regional/local business centres. In 2009 two more business incubators were established in Plav and Kolasin. Business incubator in Bar has firms as tenants which perform different businesses while incubator in Podgorica has got IT business “tenants”. Preparation activities for the establishing of the business incubator for service – manufacturing businesses in Berane are in progress. Project for the establishing technological park has been nominated within IPA Cross Border Adriatic Cooperation Programme.

The strengthening the economy competitiveness and stimulating the export orientation are implementing through the measures of the Export Promotion Strategy and the Strategic Operational Plan. Activities regarding the providing relevant information to SME are implementing continuously. In November 2009 market informative service was established which will enable to SME direct approach to data bases on the international markets and by these activities will strengthen the export oriented companies. European Centre for Information and Innovations which provides a practical information and assistance to SME in order to improve the competitiveness and internationalization became operational. Promotion of entrepreneurship and SME is still organized through the promotional activities, the fair exhibitions and the business meetings. The exhibition of the Montenegrin companies has been organized on the fair manifestation in the region, Europe, Russia, India, UAE, etc.

In the area of business knowledge enhancing, the project Business Innovation Programs (BIP) is in the implementation process in the Montenegrin six secondary schools (Tivat, Kotor, Mojkovac, Bijelo Polje, Berane, Plav). Also, project “Chance for young managers” was implemented in Podgorica, Bijelo Polje, Niksic and Cetinje. Its aim is to provide the conceptual, administrative and experts knowledge and skills which are necessary to young managers for the effective business performance. Result of this Project is that 90% of attendants have found a new job. Further plan is to organize the same project in Danilovgrad and Kotor.

Further policies and measures for development of SME are refers to the:1. Strengthening the institutional support for SME development. Capacities of the

existing regional/local business centres and the existing business incubators will be improved. New business incubators will be established. Activities on the establishing of the Technological Park will be initiated. Support to the cluster and cooperation development will continue.

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2. Strengthening the economy competitiveness and stimulation of the business orientation. Continuation of the implementation of the Export Promotion Strategy. In 2010 promotion of Market Informative Service is planned for the companies form Montenegro, as well as for institutions/organizations which deals with development of SME and entrepreneurship. Register of exporters will be created – data base of Montenegrin exporters and export products.

3. Improvement of business knowledge through the implementation of the educational programs – trainings in the area of business skills, management, marketing, business communication, internationalization and export (organization of seminars, workshops, trainings in order to establish new and improvement of existing SME performance), implementation of Action plan of Strategy for Entrepreneurial Learning.

4. Promotion of the entrepreneurship and SME through the improvement of the marketing activities, improvement of public relations, promotion of new companies establishing - start up, increasing the level of cooperation with international institutions, promotion of women’s activities in business.

Bearing in mind significant changes in Montenegrin economy (in the area of banking sector, capital market, economic development priorities and demands, overall economic environment, regulation) there was requirement for transformation of the Development Fund and adjustment of its mission and objectives to the further economic development and Government of Montenegro economic policy.

Legal status of the Development Fund would be determined through its transformation to the public owned joint stock company. Basic intention of the Development Fund transformation is to organize the Fund as the individual legal entity in order to enable the appropriate preconditions for future institution (Fund) to justify efficiency of its business performance.

There are several arguments in the favour of Fund transformation into Joint Stock Company:

- As the independent economic subject Fund would operate on the principle of self sustainability;

- As the joint stock company Fund would dispose with more instruments (shares, bonds, portions, credit lines, guaranties etc.) for the accomplishing of defined objectives;

- Fund would be open institution for the international and domestic cooperation;- Enabling the efficient operation with an optimal number of executives who are able to

implement Fund’s business policy;- Defining of the legal position of the institution and applying of the appropriate

regulation.

The objectives of the newly established subject, as basis for further Fund’s development, will be as follow:

- Support to the realization of the infrastructural and ecological projects;- Regional development balancing;- Support to micro, small and medium size enterprises, inter alia;- Privatization of the rest of the state capital in the Fund’s portfolio;- Existing placements realization.

The most significant activities of the Fund will be credit and guarantee operations. Law on establishing if the new Fund prescribes that the Government of Montenegro will guarantee for Fund’s obligations which means that Fund’s guarantees will be covered by the first class collateral, in accordance with international principles. Government of Montenegro adopted Law Proposal on Investment Development Fund on its session of December, 3 2009 as well as Parliament of Montenegro on the end of 2009.

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Financial funds for the implementation of this Law will be provided from the Fund’s existing funds and the Directorate for Development of Small and Medium Enterprises funds assigned for SME sector support which are on the commercial banks accounts currently.

Business environment

Creation of the economic system and institutional framework which will provide simulative business environment is the one of the strategic priorities of Montenegro. In the previous period, the different reforms have been implemented in the all areas of the economic system. These reforms were oriented to build as much as possible favorable business environment. Under abovementioned reform activities Government of Montenegro has established the Council for Elimination of the Business Barriers.

Main task of the Council is to organize and coordinate the activities of the Government bodies and other relevant institutions in the area of the business barriers elimination. Council has the mandate to propose to the Government the adoption of the new regulation as well as amendments of existing regulation which will contribute to the elimination of business barriers. On the basis of the proposals and recommendations given by government bodies, economic subjects and business associations, Council prepares and proposes the Plan for elimination business barriers to the Government. Council cooperates with the international organizations and institutions in order to improve business regulation in Montenegro, as well as bilateral cooperation with institutions of other countries which are successful examples in the area of business regulation and elimination of the business barriers. Council is chaired by Deputy Prime Minister for international economic relations, structural reforms and business environment improvement.

On the Council’s initiative the Act on Government of Montenegro Internal Rules has been amended in the part which regulates the procedure of the proposing of the laws and other acts to the Government. According to these amendments under the new procedure, proponents of the laws and other acts are obliged to provide positive opinion, issued by the Ministry of Finance, which proves that there are not business barriers in the provisions of proposed act. In accordance with abovementioned, in the Ministry of Finance, special Department for improvement of business environment has been established which is in charge for issuing of the opinions on the proposed laws and acts from the point of their impact on business environment. Other activities of the Departments are related to the administrative support to the Council for Elimination of Business Barriers, cooperation with international organizations in the area of business regulation improvement as well as cooperation with private sector. Since July 2009 Department has issued about 140 opinions on the different laws and acts.

Considering the business environment in Montenegro, it is obvious that there are a lot of possibilities for improvements in this area, especially in the area of duration, costs and procedures for licensing, in other words, the proceedings of the state administration in different procedures. World Bank Doing Business Report 2010 findings confirms in the favor of the abovementioned fact. Montenegro improved its position for the six places up on the Doing Business 2010 global list. On the basis of the recorded reforms in Montenegro, DB team assessed that Montenegro has improved in the four of the ten analyzed indicators. Only 11 countries reformed better than Montenegro according to score by indicators. Reforms were made in the area of starting business, dealing with construction permits, paying taxes and employing workers. In the rest of the DB analyzed indictors (areas) Montenegro has not come forward, due to the fact that it has not reformed while other countries reformed better and outstripped Montenegro on the global list.

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In order to intensify activities on the elimination of the most important business barriers, Government of Montenegro – Ministry of Finance has launched cooperation with the World Bank in the area of drafting of the recommandations for the further reforms. In the cooperation with World Bank, Government of Montenegro has adopted Doing Business Reform Action plan which consists the measures for improving of the business regulation.

Action plan activities which will be implemented in the next short and long term period are related to the changing or abolishing the laws and other regulation, shortening of procedures as well as reducing their costs. In that sence, during the next period of time main activities will be related to the implementation of the Law on spatial development and construction building, amending the Law on Business Organization, Law on general Administrative Procedure, adoption of the Law on executive procedure, Law on insolvency and Law on courts fees.

At the same time, preparation activities for the Regulatory Reform Project are in progress. This Project will be implemented in the cooperation of the Ministry of Finance and the International Finance Corporation during the next 15 months. Project consists of three components: regulatory Guillotine, Doing Business indicators and implementation of Regulatory Impact Assessment.

This Project is aimed to strengthen the business environment through implementation of the integral methodology for the systematic revision of the business regulation in order to eliminate unnecessary, dysfunctional and obsolete regulation, shorten administrative procedures and reduce the administrative costs. Revision of this regulation would be a kind of the guillotine by which long-lasting and expensive administrative procedures will be excluded from the economic and legal system and will assure that Montenegrin accomplishment of competitive market economy standards.

Second component, related to the Doing Business indicators will be implemented through the selection of the areas where the reforms are mostly needed. That would be Doing Business Indicators: starting business, paying taxes, cross border cooperation, dealing with construction permits, registering property.

Third component refers to the implementation of the Regulatory Impact Assessment. Activities of the issuing opinions on the proposal of regulation which are organized within the department for business environment improvement could be considered as precursor for RIA implementation.

It is expected that implementation of the Doing Business Reform Action plan and Project of the regulatory reform in the next two years significantly contribute to the business environment improvement as well as elimination of the business barriers which should lead to strengthening SME sector and economic activity and consequently to higher economic growth and recovery of the economy affected by the global financial crises.

Project will be financed mutually by the Government of Montenegro (50%) and International Finance Corporation (50%) by the funds amounted to 350.000 euro (500.000 $). Experiences of the countries which have implemented similar projects show that effects on the budget savings are usually ten folded. In that sense, it is expected that implementation of Action plan measures and activities will contribute to savings for state budget and economy valued about 4 millions euro.

Tax aspect of the business environment

Tax policy in 2009 was driven towards further improvements of the Montenegrin tax system in order to enhance business environment and strengthen the investments, bearing in mind

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EU legislation and practice. It was continued with the trend of decreasing and equalization of tax rates, abolishing of tax deductions and elimination of exemptions. In the further period of time, special attention will be given to the improving of the service to the tax payers.

In the area of the direct taxation, corporate income tax rate was kept on the level of 9% in 2009 and it is the lowest in the region. Planed decreasing of the fiscal burdens on the wages has been implemented. Related to that, personal income tax rate as of January 1 2009 has been decreased from 15% to 12% and as of January 1 2010 it will be 9%. At the same time mandatory social insurance cumulative contributions rate has been decreased from 34% to 32% as of January 1 2009. Simplified procedure of unified registration of the PIT and social security contributions taxpayers, organized by one tax return has been successfully applied while the model of unified calculation and collection of abovementioned obligations is in the testing phase which is being implemented by Tax Administration in cooperation with tax payers.

Further implementation of the tax reform with basic commitment of the simplification of tax procedures, low tax rates with as much as possible broad tax base and insignificant number of tax exemptions is in progress. Related to that Parliament of Montenegro adopted the set of tax laws on its session held on December 17 2009 as follow:

- Amendments on the Personal Income Tax Law, by which: is abolished tax relief on the “personal deduction” amounted to 840€ annually (70€ monthly); are balanced tax rates on all sources of personal income tax and decreased the standards expenditures (from 40% to 30%) in the process of calculation of taxed income on occasional business activities which contributed to decreasing of the effective tax rate and created better business environment; is introduced the taxation on some benefits based on working contract (benefits for meals, transport etc) in order to broaden the tax coverage and equalize tax treatment; is introduced obligation of the taxation of incomes on capital gains based on real estate selling, shares in companies and securities (this provisions will be applied as of 1 January, 2011);- Amendments on Social Security Contributions Law by which is increased the cumulative contributions rate. Provisions of the Social security contributions Law (Official Gazette no 13/07, 79/08) prescribed the decreasing of the contribution rate from 32% to 30% as of 2010. Namely, in the context of decreasing the personal income tax rate from 12% to 9% as of 2010 and overall liquidity problem caused by global financial turmoil, the fiscal structure of the wages has been changed including the social security contributions structure. Cumulative contributions rate has been increased by 1,8% (from 32% to 33,8%) through decreasing of the fiscal burden based on contributions paid by employer from 14,5% to 9,8% (which will cause decreasing of the employers costs) while tax burdens on wages based on contribution paid by employees has been increased from 17,5% to 24%;- Amendments on the Corporate Income Tax Law by which is decreased the number of tax exemptions as well as abolished monthly advance paying of corporate income tax. These measures will contribute that companies will have more disposable funds for financing of the current operations;- Amendments on the Tax Law on Using the Passenger motor vehicles, motorcycles and Vessels (with cabin).

Above-mentioned amendments will be in implementation as of January 1, 2010 and overall positive effect on Budget would be around 30 millions of euro.

In March of 2009, in the area of indirect taxation, the Decree on the postponed payment of customs obligations (Official Gazette 25/09, 48/09) was adopted for the temporary period of time and is valid up to December 31, 2009. This Decree is adopted as response on global financial crises and as measure in order to diminish its negative effects. It prescribes possibility for postponing of the payment of customs obligation (customs and tax) based on imports of goods, on the period of 30 days from the day of customs declaration acceptance.

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This provision creates more favourable condition for the continuation of the imports of goods necessary for realization of many investment projects. Also, in order to provide additional budget revenues, in June 2009, the Law on amendments on the Law on excises (Official Gazette 50/09) was adopted by which excises on mineral oil (lead acid petrol, unleaded petrol and gas oils used as motor oils)are increased by 0,10 € per liter. For the other mineral oils18 excises are increased by 30%. This law, also, prescribes that the provisions from the previous law amendments regarding increasing of specific excise rate on cigarettes from 3€ to 5€ (for 1000 pieces) as well as proportional excise rate from 30% to 35% of retail price of cigarettes will be implemented as of October 2, 2009, instead of January 1, 2010 as it was prescribed by the previous amendments19. Implementation of this law will contribute to increase of excises revenues by approximately 20 millions of euro comparing to 2009.

In the area of customs, in July 2009, it was adopted Decree on conditions for performing pleading operations in the customs authority (Official Gazette no 50/09) which prescribes more flexible conditions for obtaining the license of the customs authority. On its session of the December 3 2009, Government is adopted the Decree on the harmonization of nomenclature of the customs tariff with combined nomenclature of EU for 2010 in order to create more favourable conditions for the foreign trading of our economic subjects. Implementation of this Decree in the area of decreasing of customs rate for certain group of goods, according to Interim Agreement with EU and Free Trade Agreement with Turkey will affect on decreasing of customs revenues in the budget by approximately 2,5 millions of euro. Preparation of Decree which will prescribe conditions for obtaining status of favorable subject20 is in progress. This Decree will prescribe possibilities for the subject with favourable status to use facilities during customs procedures.

In the next time, Ministry of Finance intends to carry out analyses of the effects of the implementation of existing regulation of key taxes in Montenegro. On the basis of this analyses findings, Ministry of Finance will prepare tax strategy for 2010 – 2014 which will be based on the current principles of self taxation, simple procedures, as much as possible smaller number of the tax exemptions as well as competitive tax rates. Strategy will be the framework for the further regulation improvement in this area bearing in mind actual legislation and practice of European Union as well as future changes in this area.

One of the important principles of future tax policy will be more efficient administration for the purpose of further simplification of the procedures and elimination of business barriers which will be accomplished trough project of unified registration and collection of taxes and contributions as well as electronic submission of tax returns and payments and better services to tax payers.

Financial reporting in Montenegro – business environment aspect

Reliable financial reporting system represents the basis for satisfactory functioning of the market economy and dynamic financial system as well as very important aspect of the business environment in the sense of availability of timely and credible information to business, investors and regulators. Ministry of Finance was adopted the Strategy and Action plan for the improvement of the system of financial reporting in Montenegro in October 2008 and thereby has started the activities on overall reform of the system of financial reporting.

18 Other mineral oils: kerosene which is used as motor oil and kerosene for hitting, gas oil for industrial and commercial uses and gas oils for hitting, stoke oil, liquid oil gas which is used as motor oil or industrial and commercial uses and heating

19 Amendments on the excises law (Official Gazette, no. 76/08)

20 Decree will be in force as of January, 1 2010.

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During 2009, in accordance with Strategy and Action Plan, Ministry of Finance has implemented following activities:

- Amendments on Accounting and Auditing law are adopted as well as complementary regulation by which regulatory framework in this area is completely established;- Accounting and Auditing Council is established. Council has consultative and advisory role in the process of development and enhancing of the accounting and auditing practice in Montenegro;- Administrative capacity for the inspection control is established in the Ministry of Finance. In the first phase of the inspection control, in the cooperation with Securities Commission and Violation Jury, officers of the Ministry of Finance had been controlling the delivering of the quarterly financial reports by the joint stock companies, banks, insurance companies and had launched 203 violation processes against legal persons due to not delivering the financial reports in the period of time prescribed by law;-In the cooperation with the World Bank implementation of the activities on prioritization of the action plan and designing of the long term reform plan is in progress. Also, through regional World Bank REPARIS program, cooperation and exchanging the experiences with countries in the regions has been effectuating constantly.

In order to improve business environment and increase the level of transparency, following activities on improvement of the financial reporting will be implemented by 2012:

Implementing the capacities for receiving and publishing of the financial reports for all legal persons on the web site of Central Registry of the Commercial Court;

Implementing the capacities for controlling of the quality of the financial reports Implementing the capacities for public supervision of the auditors and quality control; Further regulatory framework straightening through adoption of the new law on

Accounting and Auditing in 2012 and implementation of the all acquis communittaire.

4.1.4. Network Industries

4.1.4.1. Energy

The total energy balance of Montenegro consists of hydro energy, oil derivatives, coal, wood and wood by-products, and imported electrical energy. Montenegro imports all needed quantities of oil derivatives, more than one third of needed electrical energy and rather small quantities of lignite. Import of electrical energy has been growing over previous years. In the period 2000-2008, this import was growing with an annual rate of 0.6%. The elements in the structure of import of oil derivatives are mazut, diesel fuel and gasoline. Over the course of previous several years, the share of heating oil was around 30%, diesel fuel around 25%, while the share of gasoline was somewhat lower (around 18%). Montenegro exports much lower quantities of energy if compared to imported quantities of energy. The electrical energy and coal make the structure of exports.

Features of the energy sector in terms of level of services and prices

The Law on Energy, in application since 2003, has regulated the issue of level of services in the energy sector partially and in rather general terms. The new Law on Energy, expected to be adopted at the begging of 2010, will govern in details the issue of the level of services in all energy segments.

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Electrical Energy: The level and quality of services in electrical energy supply are different in different parts of Montenegro. Problems in respect of safe and reliable supply of electrical energy to consumers are pronounced in the northeast part of Montenegro and on the territory of the Municipality of Kotor. In order to secure higher quality and reliability in supply of electrical energy to consumers, a series of projects are under implementation for construction of new and reconstruction of existing structures of the transmission and distribution system of electrical energy. The rulebook on electrical energy tariffs governs the manner of establishing of charges of electrical energy undertakings for carrying out electrical energy activities and manner of setting tariffs for sale and purchase of electrical energy supplied, as well as for services provided regarding such supply to consumers/customers by electrical energy undertakings.

During 2008, some intensive activities were evidenced in terms of creating conditions for opening the electrical energy market, which resulted in adoption of the Decision on Opening of the Electrical Energy Market by the Energy Regulatory Agency on 30 December 2008. In accordance with that Decision, the market is open for all consumers, except for households, starting from 1 January 2009. The Decision has established that the organisation and operation of market will be carried out in accordance with the Market Rules, which were prepared at the end of December 2009 by EPCG and approved by the Energy Regulatory Agency. The objective of the Market Rules is to create prerequisites for the functioning and development of the electrical energy market. The electrical energy market consists of the wholesale market, where participants are producers, traders, and suppliers of electrical energy, as well as qualified buyers/self-suppliers, and retail market where participants are suppliers and qualified buyers i.e. customers that acquired right to select directly a supplier of electrical energy. The development and liberalisation of the market will take place gradually, in accordance with the development of competition and overall relations in the market. In the initial period, following the opening of the market i.e. until the entry of competition in supply, all end-users have right to be supplied from public supplies according to the regulated tariffs, except for buyers supplied under special contracts.

Pursuant to the Decision on Approving Prices Tables for Electrical Energy, adopted by the Energy Regulatory Agency on 29 November 2008, the electrical energy prices were increased for all consumers except for distribution consumers connected to 0.4kV voltage network, which do not classify in the category of households. There were not increases in prices of electrical energy in 2009. Considering that the existing prices apply until 31 December 2009, the Energy Regulatory Agency has adopted the new decision on electrical energy prices at the end of December 2009.

On 4 December 2008, the Government of Montenegro adopted the Program of Subsidising Electrical Energy Consumers for period from 1 December 2008 to 31 December 2009, in order to protect consumers and find-out options to establish more regular payment of invoices for electrical energy. This subsidising program covers all distribution consumers connected to 0.4kV voltage network (small and medium-size enterprises engaged in services and craftsmanship activities, as well as small-size industrial consumers), in addition to users of social protection rights and other classes of households meeting certain conditions, as well as all distribution consumers connected to 10kV and 35kV voltage networks and the Railways of Montenegro. Having in mind present economic crisis and relatively high prices of electrical energy for distribution consumers, in particular consumers connected to 0.4kV voltage network (other consumption – 1st and 2nd degree), on 26 March 2009 the Government adopted the Model of additional subsidising of consumers of electrical energy for categories of distribution consumers connected to 35kV, 10kV, and 0.4kV voltage networks which was applied from 1 April to 30 September 2009.

Until April 2009, the Elektroprivreda Crne Gore AD Nikšić (EPCG), whereat the state had

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70.59% ownership, was the only electric power company in Montenegro engaged in generation, transmission, distribution, and supply of the electrical energy. EPCG was organised into four functional segments: Generation, Transmission, Distribution, and Supply; and two organisational segments: Headquarters and Elektrogradnja. At the end of March 2009, a spinout of the Transmission from the EPCG was made, and the company called the Transmission JSC (Prenos AD) established. This joint stock company has started its functioning as an independent legal entity in April 2009. The Transmission JSC Podgorica undertakes activities of transmission of electrical energy, as well as role of the transmission system operator and (temporarily) electrical energy market operator. In mid 2009, the Transmission JSC became member of ENTSO-E association (European Network of Transmission System Operators for Electricity).

The third party access principles are applied in Montenegro in a non-discriminatory and regulated basis, in accordance with the Rules on Third Party Access in transmission and distribution network. These Rules govern the third party access in transmission and/or distribution network, which include the rights of third parties – market participants that can under equal just conditions which are known in advance enter into contracts with transmission network operator or distribution network operator for network access in order to carry out their licensed activities.

Oil: The functioning of companies operating in the field of oil and oil derivatives is organised as a market-based activity. Numerous oil companies are engaged in supply of oil derivatives of consumers in Montenegro, thus it could be said that the competition principles are achieved. The only element which does not allow for the full competition to take place in the field of oil products and gas is the fact that the largest company engaged in this activity, Jugopetrol from Kotor, is the owner of majority of storage capacities in Montenegro. Companies are procuring certain quantities of oil derivatives by direct purchase on international tender (Steel Mill Nikšić, Aluminium Plant Podgorica, Directorate of Public Works, and other).

Prices of oil derivatives are established every 15 days in accordance with the Decree on the Manner of Determining Maximum Retail Prices of Oil Derivatives. The core elements of this calculation are the price of oil derivatives on the world market and currency ration EUR/USD.

Draft Rulebook on Quality of Oil Derivates was prepared but it was referred from the ministry which prepared it to the ministry in charge for environmental protection. Decree on Quality of Oil Derivatives is planned to be prepared in the second quarter of 2010, defining the manner and deadline for elimination of fuels containing lead, the manner of control of fuels in locations where the trade in oil and oil derivatives takes place, as well as the competent authority for implementation thereof.

Gas: Network energy system for gas is still not developed in Montenegro. The level of services and prices in the gas sector is guided to a great extent by the fact that Montenegro does not have a developed gas network. Montenegro uses liquefied petroleum gas (LPG) which is imported. LPG in the Montenegrin market is present in form of small steel containers, small tanks used by the services sector and households, and in large tanks of various capacities for industrial and hotel consumers, and as autogas. Several economic undertakings are engaged in distribution and sale of LPG (Jugopetrol - Kotor, Energogas - Podgorica, INA Crna Gora – Tivat) and their number is constantly growing. The price of liquefied petroleum gas is established on market-based principles.

Status and efficiency of the regulatory authority

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The Energy Regulatory Agency carries out activities of an energy regulator in Montenegro, and is established as an independent, functionally autonomous and non-profit organisation. During the second half of 2008 and first half of 2009, the Agency adopted several enabling regulations which were necessary for opening and functioning of the electrical energy market.

Tendency and existing measures of the Economic Policy

The Economic Policy of Montenegro for the energy sector will be conducted within the Energy Development Strategy of Montenegro until 2025 in the forthcoming period. The action plan for implementation of the Energy Development Strategy of Montenegro for period 2008-2012, adopted by the Government in October 2008, envisages the realization of large number of programs and projects. The activities to create conditions for energy investments are planned, in particular for construction of new energy generation capacities and energy interconnections with neighbouring countries, revitalisation and modernisation of existing energy structures, increasing of energy efficiency in energy generation and consumption sectors, reduction of the adverse effect of energy structures on the environment, and incentives for the higher use of renewable energy sources and cogeneration.

In order to harmonise the national legislation in the field of energy with the legislation of the European Union, the new Law on Energy and Law on Energy Efficiency are under preparation. Their adoption is expected at the beginning of 2010. The Proposal of the Law on Energy, which was adopted by the Government in December 2009, contains provisions of the previously prepared Draft Law on Gas dealing with the internal gas market and of the Draft Law on Renewable Energy Sources. Furthermore, the Proposal of the Law on Energy also contains provisions dealing with the safety of supply of electrical energy and gas, cogeneration, as well as provisions dealing with the minimum requirements of 90-days oil derivatives reserves. The Law on Energy Efficiency will establish core legal bases for the development of the energy efficiency system, rational use of energy and energy savings in the final consumption sectors. The Law on Energy will govern the energy efficiency in plants for generation and transformation, transmission and distribution of energy.

In order to create conditions for the construction of new, and revitalisation and optimisation of existing electrical energy structure, a Project of Partial Privatisation and Recapitalisation of the Elektroprivreda Crne Gore AD Nikšić was carried out in 2009. The transaction was closed after the Italian company A2A S.p.A met all conditions from the Contract on Sale of Part of Shares and Recapitalisation of the Elektroprivreda Crne Gore, signed with the Government of Montenegro on 3 September 2009. In addition to state shares and newly issued shares, this company purchased shares from privatisation funds and majority of shares from remaining minority shareholders, thus it was registered as owner of 43.7% of shares of Elektroprivreda Crne Gore. The financial effect of this transaction is around 430 million euro (44.4% for state shares and newly issued shares of EPCG, 23.3% for shares of minority shareholders, and 32.3% for shares of funds). According to the Contract, the company A2A S.p.A. should increase the efficiency of the operation and carry out investments plan through the management of Elektroprivreda. In line with that, the plan is that significant increase of capacity and annual generation of the existing generation facilities is achieved through implementation of various projects, as well as reduction of the adverse effects of the TPP Pljevlja on the environment, reduction of the number and overall duration of interruption of electricity supply to consumers, decrease in distribution network losses and increase of the collection rate of consumed electricity.

Several projects are currently being implemented, and so precisely:

- The project “Year of Energy Efficiency” is being implemented, which is based on intensive

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promotion of priority activities in the field of energy efficiency, through implementation of 17 specific programs supported by a continuous promotional campaign. The implementation of the Project started in November 2008, and officially ended in December 2009, but activities which were initiated will also continue in the coming period.

- According to the Concession Contracts, entered into in September 2008, the concessionaires are implementing activities in terms of exploration and construction of small hydro power plants in 8 watercourses.

- The tender procedure for awarding concession for the construction of small hydro power plants in ten watercourses with distinct hydrological features in Montenegro, in line with the tender published on 15 September 2009, is underway.

- The preparation for publishing of the tender for construction of wind power plants in locations where explorations and measurements on wind potential are completed, is underway.

- The preparation of the tender for selection of the concessionaire for construction of 4 HPP on the Morača River, is underway and it should be published in January 2010. Total designed capacity of these hydro power plants is 238MW, and estimated annual generation is around 694GWh.

- Preparatory activities for the project on construction of the HPP Komarnica, capacity of 168MW and annual generation of 232GWh are being implemented.

- The tender for awarding the concession for exploitation of coal in the Maoče Basin (territory of Pljevlja), conditioned by the construction of a thermal power plant with the estimated capacity of 500MW, is published on 9 November 2009.

- In order to raise the energy efficiency on the generation side, the revitalisation and modernisation of existing electrical energy generation facilities is taking place (HPP Perućica, HPP Piva, and TPP Pljevlja), which should provide for their optimisation and increase of the overall annual generation for around 4000GWh.

- Activities for implementation of the Project for construction of the 400kV transmission line Podgorica-Tirana, the Project for the construction of submarine high-voltage direct current cable between the power systems of Italy and Montenegro, as well as series of other projects dealing with reconstruction and expansion of transmission and distribution electricity network are underway.

As far as gas is concerned, under the Action Plan for the Implementation of the Energy Development Strategy of Montenegro for period 2008-2012, the project of gasification of the city of Podgorica with the distribution gas network and the Project of construction of the Ionian-Adriatic gas pipeline are planned. Numerous activities under these projects, which are determined by the Action Plan, were not implemented, mainly due to the economic crisis. A memorandum of understanding is signed for implementation of the Project of construction of the Ionian-Adriatic gas pipeline between companies PLINACRO and EGL, a joint working group PLINACRO-EGL was established, creation of the inter-state body of Albania, Montenegro, Croatia, and Bosnia and Herzegovina was initiated, and analyses and studies of various options for routes and configuration of the gas pipeline system were developed (spatial and technological and economic considerations).

It is expected that the realisation of the said projects will contribute to the mitigation of the consequences of the economic crisis and to the economic development of Montenegro.

Fiscal effects of the Action Plan for Implementation of the Energy Development Strategy of Montenegro for the period 2008-2012

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The Action Plan envisages the implementation of programs and projects having total value of 1,391,081.000 euro, where the state should participate with 22,678,000 euro. Activities that will be co-financed with budget resources are as follows: (i) raising energy efficiency and use of renewable energy sources by consumers (€2,615,000); (ii) increasing the efficiency of existing energy generation facilities and energy supply facilities (€700,000), (iii) preparation of the plan for mitigation of the consequences of the climate changes (€200,000), (iv) development of the institutional framework and participation of public in development of competitive and market oriented energy sector (€7,960,000), (v) construction of and exploitation of renewable energy sources (€6,450,000), (vi) increase in generation of clean energy from fossil fuels (€1,560,000), (vii) development of a base for a long-term energy development of Montenegro (€1,343,000), (viii) development of mechanisms for efficient monitoring and control of the implementation of the Action Plan (€1,850,000).

4.1.4.2. Transportation

The share of transportation in GDP of Montenegro for 2008 was 11.3%, which is somewhat less than 13.3% in 2007. The Transportation Development Strategy of Montenegro, adopted on 3 July 2008, defines the development of transportation. The basic goals of the strategic development of the transportation system of Montenegro are: improvement of security and safety, in order to save human lives, material values and preserve state funds; integration into the European Union, through the connection to TEN-T and improvement of the competitiveness of the domestic transportation industry; improvement of the quality of transportation services; stimulation of economic growth through more efficient and cost-effective transportation; minimization of negative impact of transportation development and transportation infrastructure on the environment and the society in general.

Road infrastructure and road transportation

Existing condition. Road infrastructure in Montenegro is characterized by the problems such as the age of the road network, unfavourable geographic terrain, its exploitation in the manner that it was not designed for, bad maintenance of roads over the last decade, pronounced seasonal cycle-nature in the frequency of transportation. In accordance with the recommendations and the practice of developed countries, parameters for providing funds for maintaining roads are approximately 2% of the total value of the road infrastructure or around 8,000 euro/km of road, which would be from 15 to 40 million euro per year for the road network in Montenegro. In Montenegro, within the period from 2005 to 2009, the amount of 9 million euro was invested in regular maintenance of the roads.

The Transportation Development Strategy of Montenegro, the Spatial Plan of Montenegro until 2020 and the Law on Roads determine the initial grounds for realization of the rational policy for managing the state roads. The tasks defined by the Transportation Development Strategy of Montenegro in the area of road infrastructure and road transportation are elaborated in the Strategy for Development and Maintenance of State Roads (adopted in July 2008), Middle Term Programme for Regular and Investment Maintenance, Reconstruction and Construction of the State Roads for the Period 2008-2011 (adopted in July 2008), the Annual Plan of Regular and Investment Maintenance, Reconstruction and Construction of the State Roads, Programme for Eliminating Bottle Necks on the Core Transportation Network in Montenegro 2007-2009 (adopted at a session of the Government on 27 September 2007). The Programme relates to the elimination of 16 bottle necks on the main transportation network, and the programme is being implemented mostly in accordance with the dynamic plan of realization that is adopted together with the aforementioned programme. The implementation of these programmes should contribute to the realization of one of the main strategic goals defined in the Transportation Development Strategy of

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Montenegro, which is quality integration in the regional and beyond that into European Transport Network.

As far as legislation is concerned, the following activities important for the road infrastructure and road transportation in 2009 were performed: - The Law on Contracts for Carriage by Road (Official Gazette, No. 53/09) was developed

and it provides for the protection of passengers and users of services of freight carriage. The Law is fully harmonized with the Convention on the Contract for the International Carriage of Passengers and Luggage by Road (CVR) and the Convention on the Contract for the International Carriage of Goods by Road (CMR), and with this law a full harmonization of the national legislation in the area of road transportation with the European Union legislation is achieved.

- Draft Law on Working Hours, Obligatory Breaks of Mobile Workers and Surveying Devices in Road Traffic is being prepared;

- The Law on Amendments to the Law on Roads (Official Gazette of the Republic of Montenegro, No. 54/09) is adopted. The application of the Law on Roads from 2004 has imposed in the practice the need to specify the provisions regarding the inspection jurisdiction at the state and municipal level. In addition to the aforementioned, due to different interpretations of the Law with respect to determining the fees for using the road land, the proposed amendments envisage that the amount of fee for using the municipal roads is determined by a competent body of a local self-government unit, provided that it cannot be higher than a fee for the highway. In such a way it is impossible to set barriers for operations of business organisations that are, due to the nature of their business activity, forced to use the road land.

- Development of the Rulebook on Conditions and Manner for Performing Extraordinary Transport on the basis of Article 55 of the Law on Roads (Official Gazette of the Republic of Montenegro, No. 42/04) is underway.

The consortium, consisting of Konstruktor Company from Split, Tehnika Company from Zagreb, and the Civil Engineering Institute of Croatia, won the tender for the construction of the Bar-Boljari Highway. Bar-Boljari Highway will link the Coast with the North of the country, up to the border with Serbia and the connection with the Central Europe. Further development of the Port of Bar (Luka Bar) and Montenegrin railways is creating the environment that will contribute to the development of the highway as a part of the modern inter-modal corridor that will serve as integration factor of the Northern part of Montenegro with the Central and the South Region. The Detailed Spatial Plan is adopted, as well as detailed designs and the Feasibility Study for Bar-Boljare Highway. Firstly, a section from Podgorica to Matesevo will be built. The Government made a decision to participate in the construction of the highway with 100 million euro, which will be invested over the period of four years of construction, and thereafter the Government will make the so-called availability payments during the concession exploitation of the road. Preliminary works on the construction of the highway have started in IV quarter of 2009.

The funds obtained from international financial institutions for the period from 2007 to October 2009 for the projects in the area of road infrastructure are as follows: - EAR donation for 3 projects and the administrative building of the Transportation

Directorate in the amount of 4.5 million euro;- EIB credit – tranche in the amount of 4 million euro was obtained under the project called

“Rehabilitation of Roads and Bridges”,- EBRD credit in the amount of 11 million euro - the funds are intended for the realization of

the project called “Construction of the Third Lane on Obzovica” and “Rehabilitation of the Mioska – Kolašin Arterial Road’.

Future activities. The Strategy for Development and Maintenance of State Roads represents a strategic document, which determines the goals and main tasks for developing and

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maintaining state roads for the period of 10 years, their dynamics and scope of realization, approximate amount of necessary funds and sources of financing. The Middle Term Programme for Regular and Investment Maintenance, Reconstruction and Construction of State Roads is developed for the period from 2008 to 2011. The main goal of the Middle Term Programme is the realization of works defined by the Strategy for Development and Maintenance of State Roads. Concrete tasks of this Programme are: defining the priority tasks for the development and maintenance of state roads, defining the sources of funds for realization of works and determining dynamics for execution of the envisaged works.

Within the development plans of Montenegro, it is determined that the Adriatic –Ionian Highway is of a strategic importance, both from economic and social aspect, and from the aspect of high standard road connection of Montenegro with the neighbouring countries. The route of the Adriatic-Ionian Highway from Trst to Kalamata having 1500 km in length goes through Italy, Slovenia, Croatia, Bosnia and Herzegovina, Montenegro, Albania and Greece, linking 7 countries of the Adriatic-Ionian initiative interested in realization of this project. Furthermore, it is important to note that in 2008 Montenegro, parallel with its initial activities for preparing the formation of the Adriatic-Ionian Highway Secretariat, as a joint regional body of Adriatic-Ionian member states, developed, within the Feasibility Study for two highways in Montenegro prepared by a consultant Louis Berger, a technical documentation in the form of the General Project for a part of the Adriatic-Ionian Highway that goes through Montenegro, sections Nudo (border with Bosnia and Herzegovina) – Zelenika and Zelenika – border with Albania. On the basis of the developed General Project, the estimated price of the construction of the Adriatic-Ionian Highway through Montenegro having the length of 95.19 km is around 920 million euro. The activities of the Ministry of Spatial Development and Environmental Protection on the development of the Detailed Spatial Plan are underway, after which the urban and technical conditions will be issued and the conceptual design for the Adriatic-Ionian Highway developed.

Other future activities in the area of road infrastructure relate to the following: - Reconstruction programme for crossroads of the state roads of Montenegro, which is

adopted at a session of the Government of Montenegro, held on 16 July 2009;- The five-year Contract of Regular Maintenance will expire in April 2010; - The construction of Risan-Grahovo-Žabljak road, which has an important role in

connecting the coastal and continental tourist area and integration of the north, middle and south region of Montenegro, will be completed by July 2010.

Air Transportation

Existing condition. Due to the effects of the world economic crisis, Public Company Airports of Montenegro (JP Aerodromi Crne Gore) recorded a fall in turnover of airplanes in the amount of 9% and of passengers in the amount of 12% in the airports in Podgorica and Tivat, compared to the previous year. At the Podgorica Airport, the works on adaptation, reconstruction and modernization of the building of the former passenger terminal were completed in August of 2009. The aforementioned building is significantly contributing to the overall airport offering and it is equipped to service numerous needs of the State of Montenegro.

In October 2008, the Law on Air Transportation was adopted, and its application has started in February 2009. The new Law regulates air transportation; conditions for its safe performance; services; researches regarding jeopardizing of the safety, accidents and serious incidents of aircrafts; searching and rescuing of aircrafts; safety, protection against aircraft noise; inspection of security; and offences. In July of 2009, the Decision on Establishing the Civil Aviation Agency was adopted (Official Gazette of Montenegro, No 45/09) and the Agency Council has been formed. The Agency is a body in charge of air

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transportation having the status of a legal entity, its own financial funds and gyro accounts. Within the implementation of the first phase of ECAA Agreement, in October of 2009, the Proposal of the Law on Ratification of the Convention for the Unification of Certain Rules for International Carriage in Air Transport (The Montreal Convention) was adopted. This Convention describes important characteristics of new aviation law, regarding responsibilities of carrier, which has become the integral part of the European Union law.

The Government of Montenegro owns 99.88% of shares of Montenegro Airlines. In September 2009, the Government of Montenegro adopted the following privatization model of the company: recapitalization in the amount of 30% of the estimated value of Montenegro Airlines, and investor who wins the tender has the right to use a call option after two years and buy additional shares of the state in the amount of at least 21%, provided that the investor meets within that period the conditions defined by a tender commission. In the meantime, the Tender Commission has been formed, which is obliged to develop a plan and dynamics of the privatization process of Montenegro Airlines, in order for the entire process to be efficient and in accordance with the aforementioned model.

Future activities. Development of the Proposal of the Law on Obligations and Ownership Rights in Air Transportation that will be based on solutions provided by the Law on Air Transportation (Official Gazette of Montenegro, No. 66/08) and relevant international conventions is underway.

Future activity of the Civil Aviation Agency will be mostly based on developing secondary regulations, which will complete the implementation process of the first transition phase and initiate the implementation process of the second transition phase of the multilateral ECAA Agreement ratified by Montenegro in October 2007, as well as on strengthening of administrative and technical capacities of the Agency. The Civil Aviation Agency has engaged EUROCONTROL experts to make Tivat Airport equipped for instrument flying, i.e. flying at night or in reduced visibility. EUROCONTROL expert team has prepared a preliminary Feasibility Study for this project, and in the following period the emphasis will be placed on the development of the procedures in compliance with international standards, which would make Tivat Airport equipped for instrument flying.

Railway transportation

Existing condition. The process of restructuring of the railway is done in accordance with the Strategy for Restructuring Railways of Montenegro that was adopted in 2007. Disintegration restructuring model has been applied, by which management of infrastructure is fully separated from transport of passengers and freight. The restructuring process is currently at the end of the second phase, i.e. further segmentation of the newly formed joint stock companies. After the phase of separating the infrastructure from operating activity, two joint stock companies have continued the restructuring process in accordance with separate programmes, which envisage the following: (i) that Railway Infrastructure of Montenegro, Joint Stock Company (Željeznička Infrastruktura Crne Gore AD – Podgorica) (Infrastructure Manager), with 72.35 % of the state ownership, is organized as holding company with three subsidiaries - limited liability companies, as follows: Infrastructure Management and Transportation Regulation Company (Upravljanje infrastrukturom i regulisanje saobracaja); Infrastructure Maintenance and Railway Stations and Land Company (Odrzavanje infrastructure i Zeljeznicke stanice i zemljiste); (ii) Railway Transportation of Montenegro Company (Željeznički prevoz Crne Gore AD – Podgorica (Passenger Transportation Operator), with 85.45 % of the state ownership, has continued the restructuring process in the following manner: (iii) at the beginning of June 2009, a new joint stock company has been formed called MONTECARGO – Podgorica (freight transportation operator), with 85.45 % of the state ownership, which deals exclusively with freight transportation, whereas parts

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of the company dealing with passenger transportation and maintenance of rolling stock remained within the same company.

By forming a Tender Commission for the railways privatization by the Privatization Council of Montenegro in March of 2009, the third restructuring phase has officially commenced, i.e. privatization. At the end of October 2009, after having prepared the tender documentation by the Tender Commission, the Privatization Council published a public invitation for the sale of the state package of shares of MONTECARGO Company. It is envisaged that the company starts the privatization process after financial stabilization and defining of the level of compensation regarding the obligations of public transportation by the state, which is expected to happen by the end of 2009 or in the first half of 2010.

For the purpose of resolving a problem associated with high indebtedness of the railway system, the Government of Montenegro assumed the debts and credit obligations of the railway companies incurred by 31 December 2008, in the total amount of around 138.2 million euro (out of which 107.5 million euro of the Railway Infrastructure and 30.7 million euro of the Railway Transportation). The debts regarding the payment of instalments with related interests based on credits intended for financing of infrastructure reconstruction and investment maintenance of rolling stock were assumed, as well as other unfulfilled obligations. In such a manner, financial consolidation of the system was achieved. On the basis of the assumed debts of the railway companies, recapitalization was done, i.e. debt for equity swap, which increased the state share up to the above-mentioned percentages.

Completing the legal framework governing the area of railway transportation shall be done by the Law on Contractual Relations in Railway Transportation, which is expected to be adopted in the first quarter of 2010, as well as by the adoption of the relevant secondary regulations based on the Law on Railway, Law on Safety in Railway Transportation, and the Law on Contractual Relations in Railway Transportation, which are being developed by the competent Ministry. Completion of the institutional framework will be achieved by strengthening of the administrative capacities in the competent Ministry and Transportation Directorate – Railway Transportation Sector, i.e. future Railway Directorate which will take over the role of the regulatory body.

In 2009, the following activities were carried out in the area of railway transportation development:

- The Government of Montenegro and the Government of the Republic of Serbia signed in March 2009 the Agreement on the Border Control in Railway Transportation, which will facilitate the cross border transportation and accelerate the train border crossing between the two countries;

- In June 2009, Ministers of Italy, Serbia and Montenegro signed the Memorandum of Understanding that envisages the development of the Study of technical and economic feasibility of works regarding the reconstruction of Belgrade-Bar railway line, which is delegated to Italian company called ITAL FERR. The total value of the project is 1.4 million euro;

- The realization of the activities have started envisaged by the Memorandum of Joint Activities on the development of design documentation for connecting Montenegro and Bosnia and Herzegovina by a Niksic-Capljina railroad, which was signed in March 2008. The development of the Feasibility Study for the construction of the aforementioned railroad by a selected consulting firm is underway, which is financed by the European Commission through CARD Programme. It is expected that the study will be completed by the beginning of 2011, and the construction might start in 2012 and it would last four or five years.

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Existing investments. In accordance with the Law on Railway and Protocol 4 regarding the Land Transport of the Association and Stabilization Agreement, Montenegro is making investments in reconstruction and modernization of the railway infrastructure through the programme annual budgets and relevant credit arrangements. The current budget allocations, on the basis of which the current and investment maintenance of infrastructure and regulation of transportation are done, are around 10 million euro per year. In addition, investments in the railway infrastructure, financed by credits granted by international financial institutions whose repayment is guaranteed by the Government, are underway. The second phase of rehabilitation of the railway infrastructure, i.e. the Railway of Montenegro II Project, is being implemented, which is planned for the period from 2007 to 2012. The following projects are underway:

1. For urgent renovation of the railway infrastructure, the European Bank for Reconstruction and Development (EBRD) approved 15 million euro. The first and second tranches of this credit in the amount of 11 million euro that serve for the works on the renovation of three landslides, four tunnels and six slopes. EBRD funds in the total amount of 3 million euro are also used for resolving redundant employees’ problem of railway companies. The third tranche of this credit in the amount of 4 million euro will be used for rehabilitation of the Ostrovica Tunnel 182. The European Investment Bank approved 34 million euro and the preliminary works are underway for the realization of the first tranche of this credit in the amount of 7 million euro, which is intended for the main overhaul that includes the repair works on the Krusevo – Mijatovo Kolo railroad covering 16.5km of open railroad, with the repair of tracks at Krusevo and Mijatovo Kolo railway junction.

2. The current maintenance of the lower and upper track is done in accordance with the planned dynamics so that the transportation is carried out with no disturbances and with the speeds envisaged by the schedule for 2009. During the first three months of 2009, sensors were installed for the control of inter-station dependence in six stations, and the delivery of exit signals at Bijelo Polje-Bar railroad and Podgorica-Albanian border crossing railroad is agreed on. Within the activity “Let It Be Clean”, the project of developing and maintaining railway infrastructure is being implemented.

3. Within the observed period, in accordance with the Programme for Maintaining Railway Infrastructure and using the aforementioned funds provided by international financial institutions, renovation of two tunnels was completed at the Vrbnica-Bar railroad (No. 175 and No. 185), two landslides (Ratac/Mrčale and Brca), as well as the Project for renovation of track bars on five steel bridges (Kosorski žljijeb, Tanki rt, Tara I, Ljiboviđa and Mala Rijeka).

4. Repair and electrification of the Nikšić-Podgorica railroad are carried out slower than expected. The value of the works performed so far was approximately 52 million euro. In order to fully complete all works on this railroad, it is necessary to invest approximately 15 million euro. Additional funds would be intended for the development of road crossings, tunnels and station facilities, landslides, and similar. The Government gave the approval for commencing negotiations with potential creditors about additional borrowing of the Railway from commercial banks for the aforementioned amount. It is expected that the full completion of works, including also the envisaged additional works, would be prolonged until November 2010 due to the existing problems in the realization,.

5. In order to improve the condition of its rolling stock, Railway Transportation of Montenegro Company (Željeznički prevoz Crne Gore) repaired and modernized, in the previous period, 10 passenger coaches that have been included in transportation during July and August of 2009. The value of executed works is 3.5 million euro.

6. MONTECARGO company completed investment repairs, within the period from July to October, on 16 freight cars and diesel-electric locomotive 661-326. Furthermore, tender for investment repairs on 3 electro-locomotives 461 was implemented, and the contract with repair company called RELOC Krajova – Romania has been concluded.

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Future activities. The process of railway restructuring will be completed by the realization of the last phase, i.e. by privatization of the holding company called Railway Transportation of Montenegro, Joint Stock Company Podgorica (Željeznički prevoz Crne Gore AD – Podgorica). For both companies of Railway Transportation, privatization is planned through joint venture with a strategic partner or sale of the state package of shares. Management of the infrastructure and regulation of transportation will be delegated to a company with majority state ownership, whose share will be increased by recapitalization. As far as infrastructure maintenance is concerned, the intention is to have a joint venture with a strategic partner, and thereafter the state shares will be sold, whereas concessions will be awarded for railway stations and land.

In the following period , it is necessary to adopt a new Law on Railway that will be harmonized with the most recent EU Directives governing the area of railway transportation (the second, third and expected fourth package), as well as relevant secondary regulations on the basis of this law and other laws regarding the area of railway transportation.

From the beginning of 2010, it is expected that the Railway Directorate would become operational, in accordance with the Decree on Amendments to the Decree on Organization and Manner of Work of State Administration adopted at the end of 2008. At the same time, the Law on Safety in Railway Transportation envisages the establishment of the following bodies in 2010: (i) investigation body in charge of investigation of railway accidents and incidents that will be within the Ministry of Transportation, Maritime Affairs and Telecommunications; (ii) body in charge of safety and notified body, which will be formed within the Railway Directorate.

For the purpose of liberalization of the transportation service market, it is envisaged that during 2010 the process of mutual recognition of licenses and certificates begins, primarily with the Railway of Serbia, and then with other interested users of the railway infrastructure of Montenegro.

In the following period, the realization of the following investment projects is planned in the area of railway transportation:

1. Future investments. From the funds of IPA 2009 and IPA 2010 allocated for Montenegro, the projects for rehabilitation of two sections of railroad Vrbnica – Bar, i.e. Trebaljevo - Kolašin and Mijatovo Kolo – Mojkovac are submitted, and the project documentation is being developed for both sections by a selected company called IPSA Sarajevo. The aforementioned projects will be implemented during 2010 and 2011.

2. For the period 2010 – 2012, it is expected that the second, third, fourth and fifth tranches of the credit of the European Investment Bank will be drawn in the total amount of 27 million euro (out of the total approved 34 million euro). The second tranche in the amount of 7 million euro will be used for the reconstruction of 8 steel bridges on the Bar – Vrbnica railroad, whereas the intended use of the other tranches will be additionally determined.

3. There are plans that the company Railway Transportation of Montenegro, Joint Stock Company applies for the credit from international financial institutions (EUROFIMA, EBRD...) in the amount of 15 million euro in order to buy 5 new electrical-engine sets. The realization of these plans is expected in the following year or two.

4. Based on the results of the aforementioned Study of Technical and Economic Feasibility of works regarding the reconstruction of the railroad line Beograd – Bar in the following few years, the reconstruction in phases of the Bar-Beograd railroad will be carried out, which will contribute to significant improvement of performances of the existing railroad that represents the most efficient connection between Italian ports and the South-East European market.

5. Upon the completion of the Justifiability Study for the construction of the Nikšić –Trebinje –Čapljina railroad and development of project documentation, it is expected that the

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works on the aforementioned section would start at the end of 2012.

Maritime

Luka Bar (Port of Bar) performs 95% of all port-related activities of Montenegro. The State is a majority owner of the Port having 54.0527% of shares. In March 2008, the Restructuring Programme for “Luka Bar AD” was adopted, which includes four phases: (i) the first phase envisages the formation of new companies and the sale of all parts of the business system that are not related to port activities. At the same time, through the formation of five subsidiaries, having limited liability, and owned by the Port, all other functions will be organized through which the core port activities on terminals will be serviced. Those companies are: “Održavanje” (Maintenance), “Pomorski transport” (Maritime Transport), “Obezbjeđenjee i protivpožarna zaštita” (Security and Fire Protection), “Informatika i komunikacije” (IT and Communications”, and “Lučko transportni radnici-Štivadori” (Port Transportation Workers); (ii) The second phase starts with the adoption and the application of the Law on Ports, on the basis of which port administration is formed, and a landlord-model of port is to be established; (iii) In the third phase, Luka Bar AD will get a priority concession for the location it has used so far, and in that phase »Luka Bar AD” and all unbundled companies will establish contractual relationship; (iv) The fourth phase envisages the privatization of unbundled companies and the sale of the majority package of the state shares of “Luka Bar AD”. The restructuring programme of the Port of Bar specifies that a joint stock company should be formed by a spinout called “Container Terminal and General Freight” (Kontejnerski terminal i generalni tereti). Public invitations for the participation in the tender for the sale of 54.0527% of the total capital of “Kontejnerski terminal i generalni tereti” are underway, as well as for 100% of interests in the limited liability company »Obezbjeđenje i protivpožarna zaštita« and 100% of interests in limited liability company “Pomorski poslovi” (Maritime Affairs).

On the coast of Montenegro, there are numerous infrastructure facilities intended for the development of nautical tourism, and one of the most important ones is Marina Bar. The State owns 19.47% of shares of the company Marina Bar. Development plans for the company Marina Bar include finding a quality strategic partner who will participate in a public tender for the sale of 54.34% of the total capital, i.e. 825.727 shares of the company.

The activities regarding the conclusion of the Agreement on Purchase and Construction of two ships for the company called “Crnogorska plovidba”, which also includes a credit arrangement with the National Republic of China are in the final phase in order to revitalize the Montenegrin shipping industry. In May 2007, the Government of Montenegro adopted the Study on Economic Justifiability of Investments in Procurement of Ships for Crnogorska plovidba AD from Kotor, with the intention to realize investment project on the basis of which the revitalization of the Montenegrin shipping industry would commence. In August 2008, the Government of National Republic of China suggested to the Government of Montenegro a commodities credit that is offered to amicable countries and which includes the involvement of Chinese companies. In accordance with this initiative and with the intermediation of the Ministry of Transportation, Maritime Affairs and Telecommunications, Crnogorska plovidba concluded with a company called Poly Technologies Inc from Peking, in Podgorica on 21 August 2009, a Preliminary Contract of Purchasing and Construction of Two Handy Ships for Carrying Bulk Cargo, having the capacity of 35.000 tons each at the price of around 18.56 million euro per ship. The Preliminary Contract has envisaged that Poly Technologies provides a commodities credit, under favourable terms, of the Chinese EXIM Bank, and to guarantee the construction of ships in accordance with the adequate quality standards and technical characteristics in a reputable shipyard Shanghai Shipyard INC. This shipyard has enough experience for the construction of the target type of ship, and its clients are, in more than 80% of cases, ship owners from the countries of the European Union, such as Germany, Denmark, Italy and Greece.

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The aforementioned decisions regarding the sending of the credit application and conclusion of the Preliminary Contract were adopted on the basis of the Business Plan of Crnogorska plovidba, which includes Feasibility Study and profitability estimate. Upon the acceptance of the Business Plan also by the Chinese EXIM Bank, on 12 October 2009, the Contract of Purchasing Two Ships and two Contracts of Ship Construction were signed by Crnogorska plovidba and Poly Technologies INC, by intermediation of the Ministry of Transportation, Maritime Affairs and Telecommunications, in Peking and Shanghai.

Contracts of purchasing and construction of ships will be valid and their implementation will start upon providing the credit arrangement under favourable terms by the seller - Poly Technologies INC from Peking. The delivery of the first ship will be for 21 and the second ship for 24 months, upon the conclusion of the relevant contract of credit under favourable terms. The specified amount of credit is 47,396 million American dollars, and it has to be fully used for the payment of ships, i.e. for 85% of the total contractual price of ships, which is for both ships 55.76 million American dollars. So, it is envisaged that 15% of the total sum (8.364 million American dollars) as down-payment is provided by Crnogorska plovidba. This amount will be paid after Poly Technologies provides an irrevocable guarantee by the first class bank for the reimbursement of the down-payment in case of cancellation of the contract of credit under favourable terms. The credit will last 15 years with the annual interest rate of 3%. Grace period is five years, and thereafter the credit will be repaid in 20 consecutive instalments, and it is specified that Crnogorska plovidba as a borrower may repay the whole amount or any portion of the credit before its due date.

It is estimated that Crnogorska plovidba, in addition to the aforementioned amount for the down-payment for the credit, will have the costs in the amount of approximately 5 million American dollars until the moment the ships are built, become operational and start to generate revenues. Out of which, the credit costs will be around 2.7 million, and the costs for obtaining appropriate class, insurance, supervision during construction, as well as ship equipment, together with operational costs until the moment of generation of first revenues will be 2.3 million American dollars.

As far as regulations governing maritime transportation are concerned, and on the basis of the adopted Law on Ports, the Port Administration has been formed, which performs the administration activities regarding the ports of national importance. On 10 February 2009, the Ministry of Transportation, Maritime Affairs and Telecommunications adopted the Rulebook on Titles and Authorizations of Seafarers’ Training that prescribes the titles and authorizations regarding training of crew members of maritime ships. In the period to come, the adoption of another three laws is envisaged: Law on Sea Protection from Pollution, Law on Navigation Safety and Security, and Law on Obligations in Maritime Area.

4.1.4.3. Telecommunications

During 2008, there was an increase in all telecommunication segments. Total revenues from telecommunications in 2008 were 295,736,504 million euro, which compared to 2007 represents an increase of 6.96%. The share in GDP of Montenegro of total revenues from telecommunications is 9.77%. Revenues from telecommunications per capita in Montenegro for 2007 were 472 euro. Adoption of the Law on Electronic Communications (Official Gazette of Montenegro No 50/08 of 19 August 2008) provided a new framework for the regulation of this area, which is harmonised with the EU recommendations. This new Law has separated regulatory and supervisory function, thus the Agency for Electronic Communications and Postal Services is newly established from the Agency for Telecommunications and Postal

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Services and technical department of the Broadcasting Agency, which is assigned with the regulatory-supervisory role, while the Ministry of Transport, Maritime Affairs and Telecommunications is assigned with the administrative-inspection role. A number of enabling regulations was also adopted. At the sessions held on 19 November 2009, the Government of Montenegro adopted the Rulebook on Internal Organisation and Systematisation of the Ministry of Transport, Maritime Affairs and Telecommunications.

Fixed telephony: At the end of 2008, the number of fixed subscriber lines was 174,013, out of which 87.25% are natural persons and 12.75% are legal entities. If compared to 2007, a decline of 1.29% in number of fixed subscriber lines is recorded. Out of this number of the fixed telephony connections, T-Com had 179,214 and M:Tel 3,799, or in percentages, T-Com had 97.82% and M:Tel 2.18%. The degree of digitalisation of fixed telephony connections in Montenegro is 100% for the second year in a row, which places our country, in respect of this criterion, in the group of developed European countries. Total revenues in 2008, in the fixed telephony segment, were 75,881,435 euro, which is 17.68% less than if compared to 2007.

Mobile services: At the end of 2008, the number of mobile telephony users in Montenegro was 1,150,459, which represents a penetration of 185.51%. If compared to the end of 2007, number of users is higher by 9.99%. Out of 1,150,459 users of the mobile telephony, there were 871,661 prepaid users and 278,848 post-paid subscribers. The increase in number of users in 2008 contributed to the increase of traffic in terms of outgoing conversation minutes, which is an increase of 30.7% if compared to the previous year. During 2007, the number of outgoing SMS messages registered was 1,158,140,248, which is an increase of 40.79% if compared to 2007. Total revenue in the mobile telephony segment was 215,545,974 euro, which is an increase of 19.64% if compared to 2007.

Internet and Broadband Access Market: All modern technologies for Internet access are used in Montenegro. During 2008, 59,727 users have accessed Internet via dial-up connections. Total traffic of dial-up users in 2008 was 264,912,428 minutes. All three mobile telephony operators offer service of Internet access via 3G modems. In 2008, 30% of mobile telephony users used mobile telephones to access the Internet. The number of Internet users in 2008 was 132,651, which is an increase of 22.4% if compared to the previous 2007. Taking into account the number of broadband connections, as well as that large number of users access the Internet from office and in educational institutions, the estimate is that there are 238,722 users in Montenegro, which is an estimated penetration of 38.5%, representing an increase of 7% if compared to the previous year. There is an increase in the fixed wireless access as well (ADSL users, WiMAX, cable modems, and dedicated lines) to 5.5% representing an increase of 2.9% if compared to 2007. If we observe the penetration in comparison to the number of households, than the penetration increases to 18.9%. The penetration of mobile broadband access is 1.4%. Total revenues in the Internet operation segment were 4,309,095 euro, representing an increase of 3.73% if compared to the previous year.

Radio Broadcasting: In accordance with issued permits of the Broadcasting Agency of Montenegro, the right to distribute radio and television programmes intended for numbers of users within the designated service zone is granted to nine operators, and so precisely: six cable and one operator for each of the following: MMDS, IPTV, and DTH. At the end of the fourth quarter of 2008, number connection for distribution of radio and television programmes using various platforms (CDS/MMDS/DTH/IPTV) was 88,002. Namely, the increase in number of users was 14,929 or a growth of 20% if compared to 2007. In absolute numbers, if compared to the first quarter of 2008, all operators have had a significant increase of connection numbers. Based on the Decision on the Establishment of the Limited Liability Company “Radio Broadcasting Centre” – Podgorica (Official Gazette of Montenegro No 21/09 of 29 March 2009), a company for provision of services of access to electronic

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communication networks and provision of electronic communication services was established. The Board of Directors was appointed and Statute adopted, upon prior approval of the Government of Montenegro.

Postal Services: In the postal services segment, the Agency issued a special license to the Posts of Montenegro to carry out universal postal services and five licenses to operators to carry out individual postal services in the domain of the universal postal service and commercial postal services. The number of postal operator increased in the segment of postal services. The funds of 1,200,000.00 euro were provided for the universal service in 2009.

Future Activities

After the adoption of the Law on Electronic Communications, the Agency for Electronic Communications and Postal Services and the Ministry will adopt the remaining enabling regulations as envisaged by the Law within their competence, and those will be harmonised with the EU directives. The deadline envisaged for the adoption of enabling regulations has expired. The reason for failure to adopt the remaining enabling regulations is the lack of capacities of the Ministry and inability to provide experts that would assist in their development.

The procedure that will define the provision of the universal service is underway. The document that will monitor the problems of the universal services is being developed with the participation of experts from the European Bank for Reconstruction and Development in addition to the administrative capacities of the Ministry and the Agency for Electronic Communications and Postal Services. The planned document will be adopted rather soon.

In order to carry out the obligations that Montenegro took under the Stabilisation and Association Agreement between the European Communities and their Member States and the Republic of Montenegro, Final documents of the Regional Radio-communication Conference (RRC-06) part of the International Telecommunication Union, and to ensure efficient transition from analogue to digital terrestrial transmission system, the plan was to adopt during 2009 an appropriate law on transition from analogue to digital broadcasting of television programmes, which would together with the Law on Electronic Media and the Law on Electronic Communications represent an adequate regulatory framework for the implementation of transition from analogue to digital terrestrial transmission of television and radio programmes. Consequently, the Work Programme of the Government of Montenegro for 2009 included, among other things, the development of the Proposal of the Law on Audio-Visual Services and Proposal of the Law on Digitalisation which will govern the transition from analogue to digital transmission, and which will be submitted to the Parliament of Montenegro for consideration and adoption, following the public discussion, in the first quarter 2010. The reasons for delays in respect of this Law are that financial resources were not provided. According to the IPA programme, the state should finance 1,050,000.00 euro and IPA 1,600,000.00 euro. The obligation of the Radio-Broadcasting Centre is 45,000.00 euro as part of the service contract, i.e. training and study tours for RDC staff.

In 2010, the attention will be dedicated to the development of the Broadband Access Strategy and the Action Plan for the Implementation of the Strategy, aimed at development of the information society and progress of the overall society in Montenegro. The plan for 2009 was to pay attention to the development of the Strategy. However, due to the shortage of funds and crisis that affected Montenegro as well, implementation of the activity is postponed for 2010.

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The program of restructuring of the Posts of Montenegro, approved by the Government of Montenegro, was prepared. The Program was adopted in the 4th quarter of 2009, whereby the Program and the Action Plan set the further schedule for the restructuring program.

The overall Budget of the Agency for Electronic Commutations for 2009 was 5,182,100 euro, having breakdown as follows:- Registration fees – 15,000 euro;- Fees for carrying out regulation and supervision of the market – 2,722,600 euro;- Fees for authorisations for using radio frequencies – 1,883,000 euro;- Fees for authorisations for using numbering – 400,000 euro;- Statutory fees under laws governing the competences of the Agency – 161,500 euro.

4.2. Financial sector

4.2.1. Banking sector

Banking system and global financial crisis

The impact of the global financial crisis on the Montenegrin banking system became evident in October 2008, and escalated in the following months, including the end of the first quarter of 2009. The crisis effects were reflected in significant reduction of deposit potential of banks, hindered access of banks to external sources of funding, reduction of inflow of funds in respect of repayment of loans caused by aggravation of the financial position of borrowers which led to aggravation of all parameters of the quality of assets and profitability, and almost total discontinuance of lending activities.

Owing to timely and coordinated actions of the Government of Montenegro and the Central Bank of Montenegro, stability and safety of the banking sector have been preserved, since already at the end of the second quarter 2009 negative trends of the balance sum, deposits and loans stabilized. Namely, the Government and the Central Bank undertook preventive actions by adopting the Law on the Banking System Safeguards which was adopted in the Parliament of Montenegro in October 2008 according to the emergency procedure, to prevent the escalation of the crisis, maintain the stability, liquidity and solvency of the banking sector in Montenegro.

Based on the Law the State guaranteed for deposits of physical persons and legal entities placed with banks registered in Montenegro in their full amounts; early repayment of debts to all banks was made at their request, and also borrowings for liquidity support was approved. The Law also envisaged the possibility to issue guarantees to illiquid banks for international borrowings or borrowings from financial institutions, as well as additional capitalisation of insolvent banks. Only one bank in the system used the credit support from the State for its liquidity in the amount of 44 million euro. In respect of early repayment of debt of budgetary beneficiaries to commercial banks, the Government “injected“ around 42 million euro of liquid funds into the banking system.

In accordance with the Law on the Banking System Safeguards, and with the aim to improve liquidity, the Central Bank was in the position to approve banks to use the funds of allocated mandatory reserve on daily basis for the period of one to seven working days, and approve short-term borrowings to 30 days, up to 50% of the amount of its capital, as regulated by the Decision on use of mandatory reserve of banks held with the CBM for the period exceeding one day and the Decision on approving of short-term borrowings to banks.

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The Central Bank adopted a range of measures in 2009 that significantly contributed to liquidity of banks:

- lowered the single rate of mandatory reserve from 11 to 10%, - banks were allowed to hold to 25% mandatory reserve in the form of Treasury

bills issued by the State of Montenegro,- the period for use to 50% allocated funds of mandatory reserve was extended

from seven to ten working days,- interest rate was lowered from 5% to 4% on annual level on the used amount of

mandatory reserve,- interest rate was lowered from 9% to 7% on annual level, on the amount of funds

of mandatory reserve that a bank fails to repay on the same day,- assets classification was harmonized with the Basel standards in respect of days

of delay, according to which nonperforming assets represent the assets overdue by more than 90 days unlike the current which implies the non-performing assets as the assets overdue by more than 60 days. Also, the assets category – loss is moved from the current over 180 days overdue to over 270 overdue days.

The new Decision on Provisional Measures for Credit Risk Management in Banks was adopted in August to enable banks to classify the restructured loans into more favourable classification group from 1 January 2009, under specified conditions, if such activity should not influence liquidity of banks in the short-term and long-term period, but will ensure regular debt servicing in the future. Also, this decision will significantly facilitate the position of bank’s borrowers – legal entities and physical persons which are in delay due to the global crisis effects.

The effects of the mentioned measures of the Central Bank on the banking system were multiple:

- three banks in the system used the mandatory reserve funds for the period exceeding one day and thus overcame the problem of short-term illiquidity,

- the amount of allocated mandatory reserve was significantly reduced due to the changed mandatory reserve policy (in relation to the end of the previous year the reduction in this respect amounted to 48.3 million euro or 22.3%),

- in September of the current year, after three Treasury Bill auctions organized by the Central Bank, banks placed the total amount of 38.1 million euro into Treasury Bills, that the State directed into the banking flows,

- the Central Bank abolished the obligations for banks to allocate general mandatory reserves from 1 January 2009, where the banks were released by around 16 million euro (as they amounted as of 31 December 2008),

- Amendments to the Decision on Minimum Standards for Credit Risk Management in relation to classification of assets by days of delay (the interval of 60 – 180 days was changed for non-performing loans to 90 – 270 days) resulted in the primary effect of releasing credit loss provisions with six banks in the system in the total amount of 10.2 million euro,

- the application of the new Decision on Provisional Measures for Credit Management Risks in Banks resulted in the primary effect of releasing credit loss provisions in the amount of around 2 million euro reserves with the tendency of further growth, and the secondary effect was the relaxation of the position of bank clients in delay due to the aggravation of the financial position under the crisis impact.

In addition to the mentioned measures, the preservation of the banking system stability was contributed by strengthening of supervision activity of the Central Bank under the crisis conditions, for the purpose of ensuring safety and stability of the banking system. These activities, in particular, increased from the fourth quarter 2008 which corresponds to the beginning of the global crisis effects in Montenegro. In the period 2009 - March 2010 the Central Bank will conduct so called on-site diagnostic examination of all banks in the system,

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and the same will represent the combination of the on-site examination and stress testing conducted by the bank and the Central Bank based on the single projection of key macroeconomic variables within two scenarios: realistic scenario and “worst case” scenario. The goal of the examination is to assess the banking system sustainability and define the requirements for capital and liquid funds at the level of each bank and for the system as a whole.

Foreign mother banks provided significant support to their subsidiaries in Montenegro in the period of the crisis for the purpose of amortizing the strong outflow of deposit potential and the pressure of clients in relation to payment of cash. In the context of anti-crisis measures that the Government of Montenegro has undertaken for the purpose of preventing negative effects of the global economic crisis, one of the measures that was, on one side, aimed at improving banking system liquidity that at the time was at a low level, and from the other side, providing cheap funds to small and medium size enterprises, was the issue of state guarantees to international financial institutions.

Already in November 2008, when the Memorandum of Understanding was signed between Montenegro and the European Investment Bank worth 200 million euro, the Ministry of Finance of Montenegro started an initiative with EIB to approve loan funds to Montenegrin banks to finance the projects of small and medium size enterprises, which was the first initiative of such nature directed to EIB in comparison to all the countries that approached it to request such kind of loans. Also, with regard to the state guarantee agreed with the European Investment Bank in the amount of 91 million euro, it is the highest amount approved for such purpose by EIB to any of the countries from the region in relation to the GDP value.

By and including December 2009, Loan Contracts were concluded between the European Investment Bank and the following Montenegrin commercial banks – Komercijalna Banka Budva, Hipotekarna Banka, Atlasmont Banka, Investbanka Montenegro, First Financial Bank, Hypo Alpe Adria Bank, Erste Banka and recently NLB Montenegrobanka. With regard to the operational aspect of loan funds by the European Investment Bank, after formal conditions had been met by Montenegrin commercial banks, the first disbursement applications were issued and first funds were disbursed in the middle of November of the current year. By the end 2009 banks withdrew 10.6 million euro, while at the beginning of 2010, another 8 million euro will be disbursed.

The Ministry of Finance is ready to approve additional funds to those banks that have implemented the arrangement, i.e. placed funds with small and medium size enterprises.

In addition to the EIB arrangement, the Government of Montenegro provided for guarantees to Montenegrin commercial banks with the German Development Bank (KfW). KfW approved credit lines for three banks – Crnogorska Komercijalna Banka (20 million euro), NLB Montenegrobanka (15 million euro) and Erste Banka (15 million euro). Out of the mentioned amount, 2 million euro is intended for providing loans to projects aimed at the energy efficiency improvement, while the remainder is intended for financing projects of small and medium size enterprises.

Banking sector performances as of 30 September 2009

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At the end of the third quarter 2009 the balance sum, deposits and capital of banks generated moderate growth rates, and the concentration decreasing trend continued as a result of reduced lending activity of banks since the fourth quarter 2008.

Balance sum. The total balance sum of banks as of 30 September 2009 amounted to 3,224 million euro, implying that it decreased by 8.15% in relation to one-year, and increased by 2.57% in the current year. Six banks in the system generated growth of the balance sum in one-year period.

Capital. The total capital of banks as of 30 September 2009 amounted to 294 million euro and they generated growth at the rate of 3.91% in relation to one-year period, and the growth at the rate of 5.27% in the current year. Four banks were subject to additional capitalization in the amount of 44.7 million euro, and two banks provided 18 million euro in respect of subordinated debt. In the period IV quarter 2008 – III quarter 2009 the total capital of banks increased in the amount of 93 million euro, of which 69 million euro in respect of the issue of shares and 24 million euro in respect of subordinated debt. However, negative financial result of banks and allocation of additional provisions for potential credit losses that have been identified in the process of regular supervision activities, had negative impact on the total amount of capital and led to its objective reduction.

Solvency ratio on aggregate level amounted to 12.86% and it is above the statutory minimum of 10%. Foreign capital has a dominant share in the structure of total capital amounting to 80.53%, and then follow the domestic private capital with 16.87% and the state (indirectly through state owned enterprises) with 2.6%. At the end of the third quarter 2009, two banks were under majority domestic private ownership, while the remaining nine banks were in majority of (five banks) or 100% foreign capital (four banks). Banks with majority foreign capital have control over 83% banking market in Montenegro.

Loans. Total approved loans of banks in the observed period amounted to 2,571 million euro and they decreased at the rate of 9.86% in relation to one-year period, and at the rate of 2.25 % in relation to the end of 2008. First negative growth rates of loans were registered in October 2008 when due to the crisis effects the lending activities of banks almost discontinued because of the problems with liquidity and hindered access to external financing sources. In the loan portfolio structure long-term loans make 73.1% total approved loans in the system. The most significant loan beneficiaries are business organizations under private ownership (58.05%) and physical persons (35.34%). The greatest concentration of loans is distinctive in the retail sector (36.96%), trade (22.60%), services, tourism and hospitality (9.08%) and construction (7.08%).

Deposit potential. The total deposit potential of banks as of 30 September 2009 amounted to 1,900 million euro. Due to the global financial crisis impact there was a significant outflow of deposits and they decreased at the rate of 18.3% on annual level. In relation to the end of 2008 deposits increased by 7.19%. The positive trend in the deposit potential of banks and the mitigation of the expressive problem of illiquidity with one bank in the system were contributed by the sale of shares and additional capitalisation of Elektroprivreda (Energy Company). The most significant depositors of banks are physical persons with the share of 40.52% and business organizations under majority private ownership of 29.54%. Out the total deposits in the system, 48.3% is related to demand deposits. The greatest concentration of deposits is distinctive with the retail sector, trade, finances and transport (72.94% total deposits). Interest rates. Average weighted interest rates on the total loans in the system amounted to 8.73% nominal and 9.40% effective. Average weighted interest rates on loans approved to legal entities amounted to 8.06% nominal and 8.65% effective, i.e. on loans approved to physical persons 9.83% nominal and 10.64% effective. Average weighted interest rates

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payable on deposits of banks amounted to 3.4%, i.e. 2.74% on deposits of legal entities and 4.37% on deposits of physical persons.

Operations of banks. The negative trend in operations of banks that began in 2008 continued in September 2009 too, when six of eleven banks in the system presented loss in the amount of 21 million euro. The profitability of banks was influenced by both subjective and objective factors. Subjective weaknesses of individual banks are related primarily to bad credit risk management which resulted in the high level of provisions additionally identified by the supervision in accordance with the regulatory framework, as well as the high level of overhead expenses. Objective factors are related to the restriction of credit growth in 2008 and due to the crisis impact the withdrawal of deposit potential from the fourth quarter 2008 and hindered access of banks to externally- funded sources.

Operations of IFI. Micro-crediting represents a significant segment in financing of physical persons. There are five micro-credit financial institutions (MFI) operating in Montenegro, which total balance sum amounted to 75.5 million euro as of 30 September 2009. The growth of the balance sum of these institutions on annual basis amounted to 7.97%, and in the current year it decreased by 4.52%. The total approved loans amounted to 68.6 million euro and they increased at the rate of 0.48%, i.e. decreased at the rate of 9.45% in the current year. The largest amount of loans was approved for financing of agriculture activity (63.35%). The total capital of MFI amounted to 19.3 million euro, i.e. it increased at the rate of 2.65% in one-year period, and decreased at the rate of 1.56% in the current year. At the end of the third quarter 2009 MFI presented negative financial result in the amount of 160 thousand euro. The total number of employees in the five MFI as of 30 September 2009 amounted to 189.

Regulatory framework development In 2009, the continuity of the regulatory base development advanced and passing and adopting of secondary legislation related to the Law on Banks were almost completed. To that end the Central Bank of Montenegro adopted the following regulatory acts: (i) Decision on Minimum Standards for Operational Risk Management in Banks; (ii) Decision on Minimum Standards for Investments in Real Estates and Fixed Assets; (iii) Decision on Methodology for Drawing-up Consolidated Financial Statements of a Banking Group; (iv) Decision on Banking Ombudsman and (v) Decision on Minimum Standards for Risk Management in Micro-Credit Financial Institutions.

Also, in 2009 some amendments of the regulatory framework were adopted, as follows: (i) Decision on Amendments to the Decision on Minimum Standards for Credit Risk Management in Banks; (ii) Decision on Amendments to the Decision on Capital Adequacy of Banks; (iii) Decision on Amendments to the Decision on Reports Submitted to the Central Bank in accordance with the Law on Banks and (iv) Decision on Amendments to the Decision on Minimum Standards for Risk Management in Micro-credit Financial Institutions.

The Council of the Central Bank also adopted the Decision on Provisional Measures for Credit Risk Management in Banks, which is primarily aimed at creation of a more flexible space for banks to manage credit risk under the global financial crisis conditions. Therefore, banks were allowed to restructure loans of such beneficiaries whose financial position aggravated due to the crisis effects, which directly contributed to relaxation of loan beneficiaries.

The decisions of the Central Bank, in the drafting phases and after being adopted, were subject to attention and assessment by relevant international financial institutions, primarily the International Monetary Fund and the World Bank. Positions of these institutions were fully positive, and therefore it may be concluded that the regulatory framework for bank

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operations in Montenegro is highly adjusted with the regulatory framework of the EU and internationally recognized standards for bank operations.

Planned activities in the coming period

The activities of the Central Bank in the coming period will be directed to strengthening of the capacities of the Central Bank and improving and strengthening of the supervision function for the purpose of implementation of the new regulatory framework.

The key activities of the Central Bank will be aimed at drawing-up and proposing of a set of legal regulations that will further improve the capacities of the Central Bank and advance the continuity of harmonising the regulatory framework with new improvements and amendments of the EU regulations. To that end, the text of the new Law on the Central Bank of Montenegro has been prepared, as well as significant amendments to the Law on Banks, Law on Deposit Insurance and the Law on Bankruptcy and Liquidation of Banks.

After the adoption of this regulatory set, in accordance with established obligations the Central Bank will continue to improve the secondary regulations originating from the amendments to these laws. The objective is to fully define the constitutional and systematic status of the Central Bank and additionally improve its capacities in 2010. Also, to that end, the regulatory framework will be further improved to the level of full compliance with the EU regulatory framework and internationally recognized banking standards.

TABLE 27: Action Plan of initiatives for strengthening of the CBM capacities and supervision function in the period 2009 – 2011.

Planned activities 2009 2010 2011 2012STRENGTHENING OF CBM CAPACITIES

1. Adoption of a new Law on CBM X X2. Amicable providing of the lead supervisor of the financial

sector for examination on consolidated basisX X X X

3. Strengthening of liaison with the ECB X X X X4. Review of mandatory reserve policy X X X X5. Financial analysis of the real sector and centralization of

the data-base within the CBMX X X X

6. Strengthening of the capacities of macro-economic modelling and statistical analyses

X X X X

REGULATION AND SUPERVISION OF BANKS BASED ON THE PRINCIPLES OF BASEL II AND EU DIRECTIVES FOR THE PURPOSE OF MAINTAINING FINANCIAL

STABILITY 1. Amendments to the Law on Banks based on the proposal

by the CBMX X X X

2. New secondary legislation acts on capital adequacy incorporating approaches from Basel II and CRD

X X X X

3. Development of supervisory modelling and centralisation of the data base for managing various risks

X X X X

4. Recognition of rating agencies X X X X5. Adoption of amendments to the Law on Bankruptcy and

Liquidation of BanksX X

6. Establishing of the banking ombudsman institute X7. Leading of prudential policy of licensing of banks and

issuing approvals for changes in equity shares X X X X

8. Establishing of clearing cooperation in the region X X9. Development of cooperation with other regulatory and

supervisory institutions in order to exchange data in X X X X

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respect of the principle of home supervision and exchange of experiences

10. Coordination and institutional linking of activities in the process of the EU accession

X X X X

11. Develop stress testing of all financial system segments X X X X

4.2.2. Non-banking sector

4.2.2.1. Insurance

Development of insurance market and influence of economic crisis

The main characteristic of the insurance market in Montenegro is that, despite the impact of economic crisis, market is still developing, although at the moment the insurance sector in Montenegro according to various indicators is significantly lagging behind the average of the developed EU member states. The gross premiums at the end of 2008 amounted €60.58 million, which is an 18.74% growth as compared to 2007. Projections for 2009 indicate that total gross premiums will slightly increase as compared to previous year. Share of gross premiums in the GDP at the end of 2008 amounted 1.82%, while for 2009 increase in this indicator it is expected. In the same time it is expected that gross premium per capita at the end of 2009 will exceed €100, which will represent a slight increase as compared to 2008.

Montenegrin insurance market is not directly influenced by the economic crisis, the influence on the sector is rather indirect. Having in mind, that insurance companies still have conservative approach in conducting business, as well as the fact that degree of integration of insurance sector in the contemporary financial surroundings is not at the high level; costs caused by the crisis on domestic insurance market will be proportionally lower as compared to the banking sector and the capital market. However, data for the first eight months of 2009 indicate that economic crisis, in line with projections in the EFP for 2008, had impact on insurance market in terms of achieved gross premiums and their structure, as well as in terms of decreased profitability. Because of listed reasons the Agency for Insurance Supervision, within regular control of insurance companies’ operations, gave special attention to the influence of the capital market risks, the credit risks and the liquidity risks on the balances of Montenegrin insurance companies.

Montenegro’s insurance market is still characterized with the low share of life insurance and the dominant share of non-life insurances, among which the compulsory insurances have the largest share. Projections for the end of 2009 indicate that, similarly to the end of 2008, the share of non-life insurance will amount around 88%, while the share of life insurance will amount approximately 12%. Observing Montenegrin insurance market, dominant share of non-life insurance is noticeable; however the increasing trend of the life insurance share and decrease of the share of non-life insurance in the total gross insurance premium is present.

During 2009, same as in 2008, on the Montenegrin insurance market operated eleven insurance companies. Five insurance companies are engaged solely in the non-life insurance, five companies are involved only in the life insurance while only one company is engaged in the both life and non-life insurance, with the end of 2010 as deadline to separate these two activities. Speaking about market concentration of the insurance companies, after 8 months of 2009, three companies with the largest gross premiums have market share of 81.53%, which is a decrease as compared to the end of 2008, when they market share amounted 89.14%. Based on available data from the insurance market, it is evident that the

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higher competition among the insurance companies has caused decrease of the market concentration.

Trend of increasing share of foreign capital, started in earlier years, continued in 2008 and 2009. After sale of 41.14% of state shares in the largest insurance company, “Lovćen osiguranje” a.d. Podgorica, at the end of 2009, all insurance companies in Montenegro are in the private ownership.

Legislation and strengthening of the institutional capacities

In line with strategic goal of Montenegro in terms of its integration within European Union, as well as activities anticipated in 2008 EFP, Agency for Insurance Supervision has undertaken activities on aligning insurance sector regulations with the EU directives and principles of the International Association of Insurance Supervisors (IAIS). In that sense, activities on improving regulatory framework for the area of insurance are implemented, and during 2008 and 2009 eleven bylaws has been passed, as follows: (i) Rulebook on the Content of Reports, Notifications and Other Data Which Insurance Company Submits to the Agency of Insurance Supervision and on the Manner and Deadlines for Submission ("Official Gazette of MNE” number 70/08); (ii) Rulebook on the Content of Opinion from the Authorized Actuary ("Official Gazette of MNE” number. 70/08); (iii) Rulebook on the Content and the Manner of Running Register on the Insurance Companies and Other Actors Which Are Subject of the Control by the Agency for Insurance Supervision ("Official Gazette of MNE” number. 70/08); (iv) Rulebook on the Manner for Determining and Monitoring the Liquidity of Insurance Companies ("Official Gazette of MNE” number. 70/08); (v) Rulebook on Detailed Criteria and the Manner for Calculating the Mathematical Reserves and the Reserves for Share in Profits ("Official Gazette of MNE” number 70/08); (vi) Rulebook on Detailed Criteria and the Manner for Calculating Reserves for Counterbalancing Risks ("Official Gazette of MNE” number 70/08); (vii) Rulebook on Detailed Criteria and the Manner for Calculating the Transferable Premiums ("Official Gazette of MNE” number 70/08); (viii) Rulebook on Detailed Criteria and the Manner for Calculating the Technical Reserves for the Reserved Claims ("Official Gazette of MNE” number 70/08); (ix) Rulebook on the Manner for Determining Business Results, Distribution of Profits, Coverage of Losses and Measures for Covering Losses ("Official Gazette of MNE” number 70/08); (x) Rulebook on Limitations in Depositing and Investing of the Technical Reserves Funds and the Funds of Guarantees for Insurance Companies ("Official Gazette of MNE” number 38/09); (xi) Rulebook on the Content and Manner for Passing Expert Exam for Intermediation i.e. Insurance Agents ("Official Gazette of MNE” number 47/09). Short-term priority in this area is passing Rulebook on the Chart of Accounts and Rulebook on the Valuation of the Balance Positions, activities on drafting these two rulebooks should be completed in the beginning of 2010.

Long-term priority is a full alignment of insurance laws21 with the European Union legislation in this area. Up to 2012 insurance sector development will reach level which enables harmonisation of the Law on Insurance with the EU directives, according to which there is full territorial openness for the insurance companies, i.e. provides opportunity for establishment of the branch offices of foreign companies without having status of legal person. In the same time, the minimum insurance sums for compulsory insurances will be aligned with the levels of insurance sums prescribed by the EU legislations.

Activities of the Agency for Insurance Supervision are and will be in the future aimed at improvement in general market performance, improvement of institutional framework and strengthening supervision capacities of the Agency itself. In realisation of this plans Agency is continuously engaged in strengthening cooperation with the Government of Montenegro,

21 Law on Insurance, Law on Compulsory Insurance in the Traffic and Law on Insolvency and Liquidation of Insurance Companies

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Ministry of Finance, Association of Insurers of Montenegro- National Bureau, Administration for Prevention of Money Laundering, Securities Commission of Montenegro, Statistical Office of Montenegro, Ministry for European Integration, local insurance companies, universities and other bodies and institutions, as well as supervisory organisations in the insurance area.

During 2009 many activities, aimed at establishment and intensifying communication with international institutions, expert bodies and associations, have been undertaken. In October 2009 Agency has joined the International Association of Insurance Supervisors International - IAIS. This fact has enabled Agency to establish closer cooperation and exchange of information with the insurance supervisors in the world. Agency undertakes all necessary steps towards strengthening the institutional cooperation and exchange of best international practice with the other regulators from the region, establishment of bilateral cooperation with the supervisory bodies. During 2009 Agency has intensively cooperated with the National Bank of Serbia, Agency for Insurance of Bosnia and Herzegovina, Agency for Insurance Supervision of Slovenia, Croatian Agency for Supervision of Financial Services and regulatory body of Austrian financial market FMA.

In development of its experts and administrative capacities, Agency is using technical assistance within two projects:

1. Within project “Strengthening regulatory and supervisory capacities of financial regulators", under 2008 IPA, twinning contract has been sighed between the Delegation of European Union to Montenegro and beneficiaries of mentioned project, among which is the Agency for Insurance Supervision. The main project goal is assistance to financial sector regulators in Montenegro in building institutional capacities through technical assistance and expert education of employees, establishment of the most advanced operational procedures, strengthening cooperation among financial regulators and securing more stability of the overall financial system. Project activities related to Agency will start in December 2009 and will last until the beginning of 2011. The objective of anticipated activities is transposing European legislation in the area of insurance into Montenegrin legislation, as well as adjustment in supervision function of the Agency in line with the best international practice in this area.

2. Project “Strengthening capacities of Ministry of Finance to efficiently plan analyze and manage the public finances in support to country’s aspirations for sustainable development and EU integration”, which is implemented through cooperation of Ministry of Finance and Capacity Development Program (CDP), Agency will since the end of 2009 benefit from experts and technical assistance aimed at strengthening regulatory capacities in the next two years period.

Agency is conducting continuous education of its employees, which is realised through participation in seminars and conferences in the country and abroad, using technical assistance of the international organisations, as well as foreign and domestic literature and magazines.

Fiscal impact of the Agency’s foreseen activities

All planed activities, which are aimed towards enhancing regulatory, supervisory, educational, record keeping, analytical, and other duties as prescribed in the Law, are included in financial plan of the Agency. Sources for Agency’s financing are prescribed in the article 175 of the Law on Insurance, which are as follows: (i) funds from insurance companies which pay 0.99% of gross premium from previous year, as a supervision fee; and (ii) taxes for issuing of licences, approvals, endorsements and authorizations determined in the Law on Insurance, as well as special fee which insurance companies pay in the case of

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pronounced surveillance measures. Sources of financing for Agency do not include any kind of foreign assistance, donations or budget loans, except for the activities on projects mentioned previously, which would be financed from the budget anticipated in the projects.

4.2.2.2. Capital market

The capital market in Montenegro is developing since 2001, as a continuation of comprehensive privatization process, especially mass voucher privatization which had influenced the character of transition and the development of market economy. The capital market has impacted social situation in Montenegro, since through mass voucher privatization to employees and citizens was distributed around 45% of state capital. On this way roughly 400.000 citizens became shareholders. This represented respect for the principles of ownership democracy and namely this system of ownership democracy was one out of the key resources for our development.

The most important development effect of the capital market is influence on education of each citizen and change in their attitude towards the business and the profits. There is no such institution, which with this speed, intensity and scope has influenced population’s knowledge on the market economy. Today people independently make decisions about the market and bear consequences of their decisions. This decision making has influenced the change of management in certain banks, funds, companies.

In the first nine months of 2009 market capitalisation has reached value over €3 billion, which is a 60% increase as compared to value of capitalisation on the January 1st 2009. Total turnover realised on Montenegrin stock-exchanges in observed period amounted over €342 million which is by 150% higher as compared to first nine months of 2008. It is important to stress that in first nine months of 2009 new capital, from emissions of shares and permanent investments in Montenegrin companies, amounted over €283 million.

In the structure of instruments, which were traded in the first nine months of 2009, trade with shares of companies made 91.65% out of total turnover, trade with shares of mutual investment funds made 2.86% of total turnover, while bonds turnover amounted to 5.5% out of total turnover.

Comparing the percentage changes of the value of stock-exchange indices achieved in the region with the changes in the values of indices on the Montenegrin stock-exchanges, it is obvious that Montenegrin stock exchanges record the highest growth of the indices value.Table 28: Change in the values of stock exchange indices in the region, 2009

Index nameValue of index,

31.12.2008.

Value of index,

31.08.2009.

Percentage change

Belgrade BELEX15 565.18 710.80 25.77%BELEX LINE 1,198.34 1,354.84 13.06%

Sarajevo SASX10 1,233.65 1,042.47 -15.5%BIFX 2,137.15 1,954.46 -8.55%

Zagreb CROBEX 1,722.25 2,009.02 16.65%CROBIS 90.62 86.78 -4.24%

Skopje MBI10 2,096.16 2,607.58 24.40%

PodgoricaNEX20 10,002.93 17,083.52 70.79%NEXPIF 5,844.64 8,962.06 53.34%MOSTE 469.53 890.88 89.74%

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On Montenegrin capital market currently operate 24 authorized participants as brokers, out of which 14 have a licence for dealers’ jobs. There are also 7 investment funds, which overall value of net assets at the end of the ninth months of 2009 has amounted €330 million. During first nine months of 2009, 24 share holders’ companies’ takeovers have been completed.

During May and at the end of September, the purchasing transactions with the EPCG shares from the portfolio of Mutual Investments Funds and privatisation process are completed. Significant inflow of fresh capital from these transactions has influenced the market growth, and the effects on demand increase and positive expectations are clearly visible.

Strengthening institutional capacities

Regulatory framework and practice of Montenegrin capital market is highly assessed from the prospective of use of the best international practice and international standards. IMF mission in Montenegro, which took place during March 2008 in its report concluded following:

“Montenegro implemented a modern system of the capital market regulation. Securities Commission has important powers and has established the framework for regulation. The Commission has also passed detailed regulation concerning operations of the investment funds, the issuers, and the intermediaries on the market and stock exchanges. …”

Along with this assessment, our regulatory system was a subject to analysis and the research by the IOSCO – The International Organisation of Securities Commissions. International team of the IOSCO has researched and confirmed that the regulatory system implemented on our capital market fulfils criteria for ranking at the A list, among the group of 50 countries, whose regulatory systems completely satisfy the demands related to the information exchange.

Commission, in development of its expert and administrative capacities, uses technical assistance within the project “Strengthening Regulatory and Supervisory Capacities of the Financial Regulators", under IPA 2008 fund. The twinning contract is signed between the Delegation of the European Union to Montenegro and beneficiaries of the mentioned project, among which the Securities Commission. The project goal is to assist the financial regulators in Montenegro in building institutional capacities through technical assistance and education of employees, establishment of the most advanced operational procedures, strengthening cooperation among financial regulators and securing higher degree of stability within the overall financial system. Project activities related to the Commission will start in 2011. The main goal of anticipated activities will be to transpose European legislation in the area of capital market into Montenegrin legislation, as well as adjustment of the supervisory position of the Commission in accordance with the best international practice in this area.

Future activities

Based on the expected development direction future activities have been planned, as follows: Improvements in regulatory framework, especially:

Drafting and implementation of the Changes and Amendments to the Law on the Investment Funds, and drafting and implementation of the Changes and Amendments to the Law on the Share Holders Companies Takeover, Development of the practice for regular dissemination of data and reports on the companies’ operations,

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Alignment of the capital market regulations with the other laws and regulations, Harmonisation of the practice in dealing with the securities.

Broadening of the market and informational linking of stock exchanges and market participants from the region and strengthening the market infrastructure, especially the reliability and the efficiency of custody banks in order to make market more visible to foreign investors, Oversight and control of the authorized participants and the issuers, Social responsibility of the Commission in the terms of education of investors, representatives of institutions and broader public, Continuation of cooperation with domestic and foreign institutions and participation in development projects (IOSCO - MMOU, Toronto Centre, IPA, EAR, IMF, World Bank, ...), Internal organization, transparency in the work and development of informational system of the Securities Commission.

4.2.2.3. Leasing

In 2009, as well as several previous years there were not changes of the regulatory framework of the leasing market in Montenegro. Also, there were not the changes of the market participants. Still, there are six market participants, of which four leasing houses and two banks which provides leasing services within their basic operations. The Hypo Alpe Adria leasing, S- leasing, NLB leasing, and Porsche leasing provide services of both financial and operating leasing, while other leasing providers are involved in financial leasing. It should be mentioned that three leasing firms are also engaged in real estate leasing - Hypo Alpe Adria Leasing, NLB leasing, and Erste bank22, while other leasing firms are providing leasing services for movable property. Five leasing providers in Montenegro is majority owned by foreign capital while one provider is predominantly in domestic ownership.

For nine months of 2009 on the Montenegrin leasing market, 950 leasing contract have been concluded which is less by 64,72% comparing with same period of the previous year. At the same time, value of the concluded contract was amounted to 25, 494 millions of euro which represents decrease of 81.59% comparing with same period of previous year. As it was the case in the previous years, for the first three quarters of 2009 financial leasing operations had significant share in the total number of contract as well as total value of the contracts. The graph to follow gives the number and value of concluded contracts by type of leasing.

Graph 2: Number and value of concluded contracts by type of leasing

22 Opportunity bank is taken over by Erste bank

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Lesing type

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Analyses of the structure of the total number of the concluded contracts based on subject of leasing shows that item passenger vehicles has dominant share of 79.8% in the total number of leasing placements. Share of commercial vehicles in the total number of concluded contracts is 8.2%, while share of construction machines and equipment is 5.4% and real estate 6.2%. In the comparison with the same period of the previous year, on the leasing market it was recorded the decrease of the share of number of contracts of the commercial vehicles, construction machines and equipment as well as ships. Commercial vehicles shows the highest share in the total value of concluded contracts of around 50% while real estate is represented with around 26% and commercial vehicles with around 10% and leasing of construction machines and equipment around 11%.

Table No 29: Comparative overview of the number of the concluding contracts by the leasing subject  Number of contacts as of

Leasing subject30. 09. 2008

(1) %30. 09. 2009

(2) %Growth rate

(2)/(1)Passenger vehicles 1.873 69,6 758,00 79,79 -59,53

Commercial vehicles 471 17,5 78,00 8,21 -83,44

Construction machines and equipment 257 9,5 51,00 5,37 -80,16Boats 28 1,0 4,00 0,42 -85,71Real estate 60 2,2 59,00 6,21 -1,67Other 4 0,2      

Total 2.693 100 950,00 100,00 -64,72

Table no 30: Comparative overview of the value of the concluded contacts by leasing subject  Contacts value in € as of

Leasing subject31. 09. 2008

(1) %30. 09. 2009

(2) %Growth rate

(2)/(1)Passenger vehicles 36.888.375,17 26,6 12.502.431,20 50,5 -66,11

Commercial vehicles 22.196.314,12 16,0 2.003.195,26 10,3 -90,98

Construction machines and equipment 23.121.566,08 16,7 2.874.783,26 11,4 -87,57Boats 3.033.406,16 2,2 447.719,00 1,5 -85,24Real estate 53.067.798,99 38,3 7.665.924,19 26,3 -85,55Other 202.528,50 0,2      

Total 138.509.989,02 100,0 25.494.052,91 100,0 -81,59

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Analyzed data shows that as of the fourth quarter of 2008 when impact of global financial turmoil have already been presented, trend of slow developments or decreasing of business activities on the market (per number and per value of the contracts) has started. Decrease was recorded in all analyzed categories and it could be concluded that volume of activities has been halved comparing to the same periods of the previous year. In the structure of the leasing users it is noticeably the decrease of share of the legal persons in the total number of the concluded contracts. Generally, overall period which was characterized by slow developments on the leasing market marks higher share of the physical persons contracts as opposed to the previous period when legal persons contracts were dominant. These developments are in the line with the strategies which were announced by leasing services providers in the circumstances of the overall economic slowdown and significant private sector liquidity problems. Substance of the leasing providers’ strategies was in the efforts to diversify the risk through redirecting the placements from legal to physical persons. Also, significant change in comparison with pre-crises period (when real estates contracts were dominant in the total contact value) is significant decrease of the share of commercial vehicles, construction machines and equipment in the total number and total value of the contracts. That is one more indicator of crises impact on the structure of the leasing operations. Despite the decreasing of the number and value of the commercial vehicles contracts its share in the total number and value of the contract has been increased significantly.

It could be concluded that the trends on the leasing markets in the last year were consequence of negative effect of the global financial turmoil and overall economy slowdown. In that sense, reduced individual spending (household sector) and liquidity problems of economy sector led to decreased number of leasing contracts. Leasing market participants adjust their business strategies to the new circumstances. Bearing in mind performances of leasing industry in pre-crises period, this sector recovery could be expected along with recovery of the rest segments of the financial system and overall economy.

4.3. Labour market

Situation and trends

Employment. Despite the fact that the influence of economic crisis has became evident in some sectors already in the last quarter of 2008, during first ten months of 2009 continued, several years preset tendency of increase in the number of registered employed persons, caused by the high economic growth and improved business environment. The average number of employees in the first ten months was by 7,884 persons or by 5.4% higher as compared to the same period in 2008 (174,523 and 165,641, respectively). The average number of employed in the fist ten months of 2009 as compared to corresponding period in 2008, observed by the sectors of activity has decreased only in the industry sector by 9.3%, while sector of agriculture records 2.1% growth, constructing sector 16% growth and services sector 8.8% growth. Within the services sector, which makes around 75% of overall employment, employment in the private services sector (45% of overall employment) has increased by 10.6%, while in the public services sector (30% of total employment) has increased by 2%. Monthly data on the number of registered employees, show that after constant increase in the first eight months it is stabilising on somewhat lower level ( employment in September is lower by 1.1% as compared to August, and in October by 0.6% as compared to September).

On the other hand, Labour Force Survey data show that the number of employed persons has decreased in the first nine months as compared to same period last year, which indicate that economic crisis probably had impacted the informal labour market, i.e. informal

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employment. Also, LFS records a decrease in the number of unemployed which has caused decrease of the activity rate by 0.7 percentage points in the first quarter of 2009 as compared to fourth quarter of 2008. Third quarter, under the seasonal influence shows better results, since unemployment decreases, employment increases while activity rate is higher by 0.6 percentage points as compared to the first quarter of 2009.

Influence of economic crisis, jet did not have significant negative impact on employment in the formal sector. One should consider this fact as relative, having in mind crisis in the aluminium industry and difficulties in KAP23 operations and connected legal persons. Following factors have caused described situation:

- Government measures aimed at alleviation and elimination of negative crisis impacts. This primarily relates to the increase of the capital budget as compared to previous year, support to the citizens and the economy through securing additional liquidity, provision of the long-term credit lines to the banking sector from international financial institutions with the aim to support the small and medium sized companies through guarantees, further implementation of the project “Job for you” aimed at employment increase, measures on reducing government spending, etc.

- Decrease of fiscal burden imposed on labour (taxes and contributions) in the last several years. Fiscal burden as compared to 2004 has decreased by 40% and has supported employment, longer job spells, and legalisation of the informal labour.

- In period from 19 June 2008 until 19 June 2009, number of employers-contributors to health insurance has increased to 23,149, i.e. by 11% (data from Health Insurance Fund), which indicates that the number of legal persons has increased by 2,294 legal persons which generated new employment.

- Employment of non-resident labour in 2009 is managed under new conditions and procedures prescribed in the Law on the Employment and Work of Foreigners, based on international standards, which to some extent has decreased attractiveness of the foreign labour for employers and had some impact on higher engagement of domestic labour force. In the first ten months of 2009 15,771work permits has been issued (9,976 for seasonal employment and 7,795 permits for employment) which is by three time less as compared to same period last year.

Although, with the presence of economic crisis, it is very difficult to give reliable projections of further development, based on observations made in recent periods, it is real to expect that the number of registered employed persons by the end of 2009 will stabilize at the lower level as compared to August when the number of employed persons amounted to 179,016. Likewise, after strong economic growth, which has caused constant increase of registered employment, with the slowdown in the growth it can be expected that the level of registered employment will change under the influence of season, i.e. employment increases in the second and the third quarter, where usually the highest level is achieved in August, and than stabilizes at some lower level. This like expected scenario of the employment dynamics could oscillate depending on the situation in the aluminium industry.

Unemployment. Favourable trends in the area of registered employment have caused that during 2009, similarly to previous years, unemployment continually decreases. At the end of October in the Employment Agency register there were 27,680 unemployed persons, which is by 66 or by 0.2% less as compared to same period last year. Registered unemployment rate in the same period has decreased from 11.1% in December 2008 to 10.7%. Similarly, as in the case of registered employment, registered unemployment increases since September, so unemployment in September increased by 1.8% as compared to August and by 4.2% in October as compared to September. Changes in the number of registered unemployed persons hide unfavourable trends. In the structure of registered unemployment

23 Aluminum company

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share of females was 45.8%, same as last year, while the incidence of long term unemployment has increased from 57.0% to 58.4%, share of youth unemployed (less than 25 years of age) increased from 15.3% to 16.5% and persons aged over 50 from 35.3% to 36.8%. Also, in observed period demand for semi-qualified labour force exceeded demand for highly qualified labour force.

Decrease in the registered unemployment in the period until August, in great measure was caused by the improvements in the business environment in Montenegro, especially in the tax policy area and the labour market regulations, which had influence on the establishment of new businesses and legalisation of the certain number of informal jobs. Also, the active labour market measures have contributed to decrease in unemployment. The most important are: (i) the programs of education (for occupation and specialist knowledge) for labour market, through which the quality of labour supply increases; (ii) the programs of vocational training for known employer through which direct employment is secured; (iii) the program of self-employment through which the development of start-up, micro and small businesses is supported; (iv) the program of seasonal employment through which employment of domestic labour force during the season is stimulated, especially from the northern part of Montenegro. Important contribution had also Program of state aid and support »Stimulating employment in Montenegro – with emphasis on the northern region and vulnerable groups«, which only with Employment Agency intermediation has included 4,087 persons.

Goals and the future regulatory measures of economic policy on the labour market

Concept of economic policy aimed at the labour market is based on the determination that the further strengthening of the market economy, improvement in the regulatory framework and active support to the entrepreneurship and the programs for new jobs creation and realisation of investment ideas, especially in the SME sector, is the most fruitful response to the challenges of global economic crisis. In the area of labour market and human resources the policies will be based on the National Strategy for Employment and Development of the Human Resources 2007-2011 and National Action Plan for Employment 2010-2011.

Priorities within labour market and employment defined in the National Employment Strategy 2007- 2011 will not change significantly, but in the context of the global economic crises the focus will be on the measures which in greater measure could contribute to alleviation of the negative consequences. Measures and activities on the labour market will be aimed at decrease in structural misbalances, removal of regional differences and possible influences of global crisis through:

- the programs of preparation for employment (training, vocational education, specialisation) i.e. improvement in the quality of the labour supply taking into account the need to decrease regional imbalance on the labour market;

- the programs aimed at new jobs opening, through provision of financial support to self-employment and small scale entrepreneurship, which will influence on the employment increase, and in that context through project “Job for you”, which will have regional development dimension;

- incentives for employment of certain categories of the unemployed (persons with disabilities, persons with unemployment spell over five years, unemployed aged over 50 years of age, redundancies, farmers, persons engaged in the public works, and those engaged during season).

Taking into account labour market dynamics in 2009, forecasts of macro-economic trends in future and estimated effects of mentioned measures, registered unemployment rate could have increasing trend in 2010, especially in the first half of the years and reach level between 11.5% and 12.0%, while the decrease could be expected in 2011 (10.5-11,0%) and 2012 (below 10%).

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Labour market administration

Strategic and regulatory framework for the labour market represent the National Strategy for Employment and Development of Human Resources 2007-2011, the Labour Law, the Law on the Employment and Work of Foreigners, the Law on the Professional Rehabilitation and Employment of Persons with Disabilities, the Law on the Social Council, the Law on Peaceful Solution of the Labour Disputes and the Law on National Qualifications. In the first quarter of 2010 the new Law on Employment will be adopted, according to which National Action Plan for Employment becomes central instrument for planning of active labour market measures, increases scope of work for private employment agencies, increases amount and decreases duration of unemployment benefits. The government has submitted to the Parliament the proposal of the Law on Union Representation, and the proposal of the Law on the Labour Fund, which anticipates protection of employees in the case of employer’s bankruptcy and settlement of employees’ claims.

Social Council of Montenegro has initiated drafting and signing “Memorandum on Social Partnership in the Circumstances of Global Economic Crisis “. Through this document the social partners have committed to preservation of macroeconomic stability and good relations through: (i) Government’s implementation of the anticipated set of fiscal and socio-economic measures aimed at prevention and elimination of the global financial crisis consequences; (ii) efforts of employers that during crisis do not fire workers in order to increase profits; (iii) efforts of unions that, in the case that employers fulfils its commitments, do not organize strikes, and by that give contribution to overcoming the consequences of crisis.

In 2009 National Strategy for Development of Volunteerism in Montenegro is adopted, while Law on Volunteerism Work, which will support development of volunteerism spirit in Montenegro, increase in employability, and thus higher employment, and inclusion of vulnerable groups, will be adopted in the first quarter of 2010.

Implementation of IPA 2008 Project “Reform of Labour Market and Workforce Development II” will start in the beginning of 2010. This project will contribute to: (i) strengthening administrative capacities of the labour market institutions, (ii) establishment and strengthening partnerships for employment on the local level and (iii) strengthening system of carrier information and counselling in Montenegro. Project anticipates also work on strategic documents in the area of employment and human resource development, creation of the unique database and the web-site, improvements in the needs analysis among employers, training and assistance to staff in the labour market institutions, within the process of aligning Montenegrin legislation to the EU legislation.

Reform of social insurance system

Health protection

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Reform activities during 2008 in the area of the primary health protection have achieved following: the new model of payment for services has put in place, e-invoices are introduced and complete process of services provision on this level of health protection is supported by IT. Through IT support new inputs for broadening reform on the secondary and the tertiary level of health protection are provided, and available information pointed out the need to define the norms and standards on the different and more modern way as compared to what is defined in the existing Master Plan for Health Protection Development.

Reform activities on the reform and development of health protection in 2008 focused on primary health protection projects and IT system, drafting of legislation and programs of health policy measures. These activities are completed in all 18 health centres. In the area of legislation following laws have been passed: the Law on Amendments to the Law on Medicinal Appliances, which is aligned with the EU directives, the Law on Conditions and Procedures for the Termination of Pregnancy, the Law on Databases in the Area of Health, the Law on Health Inspection, The Law on Assisted Reproductive Technologies, the Law on Obtaining and Transplantation of Body Parts, Law on Emergency Assistance, the Law on the Control of Production and Sale of Substances Which Can be Used in the Production of Drugs and Psychotropic Substances, and within visa liberalisation process Rulebook on Content of Pharmacological and Toxic Examination of Medicines. The Action Plan for Fighting Corruption in the Area of Health 2009-2012 is adopted as well as National Program of Fight Against Diabetes, with framework Action plan for activities anticipated in the Program for period 2009-2015. The Program of Blood Donations, aimed at achieving the self-sufficiency in the provision of blood and components of blood and fulfilling higher standards in the security of the collected blood units, is adopted.

The new contract (BCA) on cooperation of Montenegro with World Health Organisation has been signed for 2010-2011, which defines framework for cooperation in the two years period. This contract defines four priorities for strengthening the health system: non-infectious diseases, promoting healthy way of life, food security, strengthening capacities for better monitoring and control of the infectious diseases and health and protection of environment. The total amount of funds allocated from the Contract for Support of Montenegrin Health Protection System Amounts to US$ 560,000.

Projects within health protection, which are underway, are final works on adaptation and reconstruction of the Institute for Public Health building, Health Centre Podgorica objects (Stara and Nova Varoš). It is expected that works on Clinic for Oncology and Radiotherapy within Clinical Centre of Montenegro will be completed soon, as well as supplying the public health institutions with the most advanced diagnostic equipment. Works are completed and the new ward of neonatology is opened in the KCCG24. From the World Bank funds will be financed implementation of measures for securing energy efficiency in general hospital Berane and general hospital Pljevlja, the tender is already announced for Berane while for Pljevlja documentation is prepared. The value of works per building is roughly €400,000.

New circumstances, caused by the financial crisis, made inevitable adjustments in the plan in terms of giving priorities to activities which are pre-conditions for successful completion of the health protection reform, and this is at the moment reform of secondary and tertiary level. The Government of Montenegro, in order to secure continuation of reforms on the secondary and tertiary level, has provided loan from the World Bank worth €5.1 million. Reform of secondary and tertiary level of health protection assumes defining and implementation set of activities of normative, organisational and technical nature, among which are the most important following:

24 Clinical center of Montenegro

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- defining norms and standards for secondary and tertiary level, basic services packages for these two levels, clinical protocols and guidelines for certain diseases, new organization of KC, network of health institutions;

- introduction of the system for monitoring and evaluation in the area of dentist protection, introduction of IBIS (integral hospital informational system), as advanced instrument for improvement and management of the system; indicators for quality control of health protection on all levels of health protection, criteria’s for accreditation of health institutions.

Reform of the secondary level of health protection will start with realisation of following activities:

- Pilot project in Pljevlja’s General hospital - implementation of the modern hospital information system, which will be part of Integral health system of Montenegro.

- changes in the Law on Health Insurance, through which supplementary voluntary health insurance will be introduced, also the law will more precisely define procedures for exercising rights from the health insurance, primarily through defining the financing of health services outside Montenegro (transplantation, child cardio-surgery).

- definition of conditions for public-private partnerships and granting concessions. - solving issues of medicinal waste is initiated by the Strategy, and having in mind need for

prompt actions and influence of the economic crisis, public-private partnership appears to be the most favourable solution.

During period from 2010 until 2012, following investments are anticipated:

- Building, reconstruction, and adaptation of the Clinic for Dermatology and Venereal Diseases within Clinical Centre, the Centre for Blood Transfusion, Emergency Centre, Health Centre Bijelo Polje, Policlinic Centre Berane, Internal Ward of General hospital in Niksic, Clinic for Neurology, Clinic for Psychiatry, Clinic for Infectious Diseases, Centre for Occupational Medicine, as well a establishment of the PET SCAN centre within KCCG under public-private partnership.

- Within World Bank loan, for continuation of the health protection reform, funds are planned for construction of the Health Centre in Bijelo Polje in cooperation with municipality of Bijelo Polje and Fund for Health Insurance. Estimated value of building is €2.6 million. From the World Bank loan €1 million is secured, while remaining funds, €0.8 million each, are provided by the .municipality of Bijelo Polje and the Fund for Health Insurance.

- Project Energy Efficiency in the following years will include General Hospital Risan, Special Hospital Brezovik, General Hospital Cetinje, General Hospital Bijelo Polje, as well as Clinical Centre of Montenegro. The value of these works is around €2.2 million.

- Construction of apartments for employees in the health institutions in Podgorica, Kotor and Tivat. Apartment construction will be financed from employees’ funds.

Revised Master Plan for Health Sector Development will be approved during 2010.

Reform of pension system

Pension reform initiated by the reform of the current financing system, i.e. first pillar of the pension system, is continued towards implementation of three pillars system. With consultations with the World Bank, the Government has decided that introduction of third pillar, i.e. voluntary pension insurance, precedes the introduction of compulsory individual capitalized savings i.e. second pillar. Existing and anticipated activities on the pension reform are as follows:

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1. Decrease in the contribution rate for compulsory social insurance should contribute to the price competitiveness of domestic workforce, new jobs opening and decrease in the informal economy on the labour market. Contribution for pension and disability insurance will in 2010 amount 20.5%, out of which 15% is paid by the employee and 5.5% by the employer, according to the Law on Contributions for Compulsory Social Insurance.

2. The Law on Voluntary Pension Funds is in force since October 2007. Up to date, three companies for management of voluntary pension funds were granted a licence - DZU25

„Atlas Penzija“, DZU „Market Invest“ and DZU „NLB Penzija“. Company for management of pension fund „Atlas Penzija“ has established voluntary pension fund „Penzija Plus“, Company for management of pension fund „Market Invest“ established voluntary pension fund „Market Penzija“. On September 21st 2009, voluntary pension fund "Penzija Plus" had 375 members, and voluntary pension fund "Market Penzija" 46 members. Securities Commission issued to five banks licences for performing custody services for pension funds, these banks are: Invest Banka Montenegro a.d. Podgorica, Hipotekarna banka a.d. Podgorica, Prva banka Crne Gore - osnovana 1901. godine a.d. Podgorica, Hypo Alpe Adria Bank a.d. Podgorica and Crnogorska komercijalna banka a.d. Podgorica.

3. Prior to final draft of the law, i.e. selection of the appropriate model which will be base for the decision on implementation of the second pillar of pension system, corresponding analysis will be done until the end of 2010. Likewise, comparative legal experiences of countries that have introduced this like systems will be examined and adjusted to conditions and specificities of Montenegro. Based on these analyses, time framework and dynamics of potential introduction of second pillar will be determined. One should have in mind that by introduction of the second pillar, rate of contributions in the existing public pension fund will significantly decrease and on this way create additional deficit, for which adequate source of financing must be find.

Social welfare

In the social welfare area the activities on implementation of adopted strategies continued: Strategy for Alleviation of Poverty and Social Exclusion 2007-2011, Strategy for Development of Social and Child Protection 2008-2012, Strategy for Integration of Persons with Disabilities 2008-2012 and Strategy for Social Protection of Elderly 2008-2012. Based on the data from the area of social and child protection negative impact of economic crisis is not apparent. Payment from the central budget of the social and child protection benefits are on time and beneficiaries of this kind of state aid will have priority in the following period.

4.4. Administrative reforms

Public administration

On 23 July 2009, The Government of Montenegro adopted the Decree on Organisation and manner of work of state administration (Official Gazette of Montenegro 43/09), which establishes 17 ministries, with the following changes in structure: competences of the Ministry of Health, Labour and Social Welfare were conferred to the Ministry of Health and the Ministry of Labour and Social Welfare. Ministry for Spatial Planning and Environmental Protection was formed by conferring the competences of the Ministry for Economic Development and the Ministry of Tourism and Environmental protection. Consequently, the tourism policy is now delegated to the Ministry of Tourism and the policy of economic development to the Ministry to the Ministry of Economy. Ministry for European Integration was also formed. The Ministry governs the association and accession process of Montenegro to the EU, coordination of the negotiation process with the EU, coordination of the harmonisation of Montenegrin legislation with the EU legislation, coordination of

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translation and management of data basis for the process of support to the translation process and coordination and evaluation of the programmes of technical and financial EU support. Thus the Ministry for European Integration undertook the competences of the Secretariat for European Integration, which has been raised to higher institutional level.

Changes in organisation, that is distribution of competences between certain sectors and forming the new ones, were necessary, inter alias, for more efficient and effective performance of work within state administration in relevant administrative areas having in mind the scope of competences of previous ministries which regulated the areas of economic development, urbanism, environmental protection and labour and social welfare as well as significance of these administrative areas for further development of economic and commercial system of Montenegro.

Apart from 17 ministries, state administration system is also comprised of 16 administrations, 10 offices, 6 directorates, 2 agencies and 1 secretariat. Apart from this, according to the Law on State Property (Official Gazette of Montenegro 21/09), the Real Estate Administration was established at the proposal of the line ministry, for performing the work in the area of property issues.

On its session as of 13 October 2009 the Parliament adopted the Law on Ratification of the Agreement on Establishment of Regional School for Public Administration (RESPA). In the reporting period, the activities on implementation of state administration reform were continued.

The preparation of the work basis of the Action Plan – Agenda of further development of the state administration reform in Montenegro for the period 2010-12 is underway.

Human Resource Management Administration

The Human Resources Administration have organised 176 trainings on 60 different topics in line with the Programme of Specialisation of Civil Servants and Employees for 2008/2009. Six of them have been organised in the newly opened Centre for Training in Bijelo Polje, which enabled an easier realisation of training for employees coming from the north of Montenegro. Apart from this, 66 (group and individual) foreign languages courses (English, French and Italian) and 18 computer courses have been organised. A Manual for State Examination for Graduate Students with six thematic areas has been prepared in the framework of the Module for specialisation of trainees and newly employed for work in public administration.

An Agreement for the Implementation of the Campaign for Awareness Raising on the Importance of Free Access to Information was signed with the OSCE and 15 seminars for local self-government employees of all Montenegrin municipalities shall be organised.

Assessment of needs for professional training of Civil Servants and Employees for 2010 is underway. On the basis of this assessment, the Programme for professional training of Civil Servants and Employees will be prepared for 2010. The adoption of the Action plan for Implementation for Civil Servants and Employees Training Strategy for the period 2009-12 is underway.

Coordination of EU integration process

After the parliamentary elections, the new Government was appointed on 10 June 2009, which defined, in its work priorities for forming mandate, the commitment of Montenegro to

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continue with its work on reforming and aligning its legal and economic system with the EU standards. Therefore, the new organisation of state administration was introduced, under which the Ministry for European Integration was established, as a legal successor of the Secretariat for European Integration. Rulebook on Internal Organisation and Job Description was adopted on 9 July 2009 and the following organisational units were defined: Sector for Coordination of Accession encompassing the Department for Coordination, Analyses and Reporting and Department for Harmonisation of Legislation, Sector for Translation, IT Support and Communications under which Translation Coordination Unit and Department for IT Support and Communications operate Sector for Programming, Monitoring and Evaluation of Technical and Financial EU Support, Sector for Regional Cooperation Programmes and Service for General Affairs.

At its session held on 25 June 2009, the Government adopted the Information on the need of establishing new coordination structures for the following phases of the EU integration and on the session held on 9 July 2009, the Government adopted the Decision on establishment of the Commission for European Integration and the Decision on establishment of groups for European Integration and subgroups for negotiating chapters

When it comes to the coordination of translation- EU legislation to Montenegrin and Montenegrin legislation and strategic documents to English language, significant progress has been achieved during the reporting period. Since the Translation Coordination Unit was established in Ministry for European Integration, within the Sector for Translation, IT Support and Communications, a solid basis was set up for the translation challenges lying ahead. In May 2009, in the framework of preparations for EU Questionnaire, a public invitation was launched for expression of interest of local translators to cooperate with the Government of Montenegro, and 230 interpreters applied26.

Ministry for European Integration prepared the Manual for Translation of Legal and other acts in the process of European Integration, which is now available on http://www.mei.gov.me. In the framework of these activities, the Government of Montenegro adopted the Information on introducing the revised Statement of Conformity of Montenegrin legislation with the relevant EU legislation, with the Table of Conformity, which was prepared by the Ministry for European Integration.

Free movement of goods

Since 1 October 2008, a considerable progress has been made in the area of free movement of goods. Laws and secondary legislation adopted and implemented in the reporting period include Law on Metrology (Official Gazette of Montenegro 79/08), Law on Accreditation (Official Gazette of Montenegro 54/09), Decree on the Method and Procedures for Assessment of Products Conformity with the Prescribed Requirements (Official Gazette of Montenegro 71/08), Decree on Conditions for Implementation of Technical Regulations of Other States and on Records of Foreign Documents on Conformity (Official Gazette of Montenegro 74/08) and Decree on Legal Measurement Units (Official Gazette of Montenegro 22/09). These legal acts considerably replaced the legislation in this area from the period before the renewal of Montenegrin independence.

Standardisation

26 162 translators who fullfiled the conditions the testing was organised, with the support of experts from the Twinning programme. Translators also completed the form, which, among other, contain the specification of their field of expertise.Thus, and also having in mind the previous cooperation, the solid base of external translators was created for translation of questions and answer tio the Questionnaire, translation of Montenegrin and the EU legislation. In cooperation with the Ministry for Information Society, 25 laptops, 4 servers and the network infrastructure were procured for the needs of the translation centre, formed within the Ministry for European Integration in July 2009 during the preparations for EC Questionnaire.

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The Institute for Standardisation of Montenegro (ISME) is the final phase of drafting the Internal Rules of Standardisation (ISME IRS), which will be harmonised with the Internal Rules of European and international organisations for standardisation.

Work Plan and Programme of the Institute for 2009, inter alia, envisaged the adoption of 1,500 Montenegrin standards and related documents. As of December 2009, the Institute has adopted cca 1600 Montenegrin standards and related documents (decisions on adopted Montenegrin standards are published in Official Gazette No 16/09, 56/09 i 82/09) which exceeded the previously planned number. The total number of Montenegrin standards and related documents which are in force is cca 2500 documents.

Work Plan and Programme of the Institute for 2010 envisaged the adoption of cca 3000 Montenegrin standards and related documents, which would represent a 100% increase comparing to the number of adopted Montenegrin standards in 2009. Bearing in mind that requested funds for the implementation of the abovementioned plan and programme could not have been provided by the Founder (the Government of Montenegro), but were significantly reduced, a revision of the work plan and programme is expected by the Managing Board of the Institute and a possible reduction in number of standards originally envisaged for adoption in 2010.

Accreditation

The new Law on Accreditation (Official Gazette of Montenegro 54/09) entered into force at the beginning of August 2009. Through this Law, requirements of the Regulation (EC) 765/2008 of the European Parliament and of the Council have been transposed into national legislation. Seven bodies (five laboratories, one laboratory for calibration and one inspection body) have been accredited for conformity assessment and first regular supervisory visits to those institutions have been performed. A great number of other organisations expressed interest for accreditation and some of them already applied.

There are ongoing preparations of the Accreditation Body of Montenegro for the full membership in the European Cooperation for Accreditation (EA). The Accreditation Body of Montenegro will host the General Assembly of the EA in November 2010. On 8 April 2009, the Accreditation Body of Montenegro (ABMNE) became an associate member of the International Cooperation for Accreditation of Laboratories – ILAC. Full membership in the International Accreditation Forum (IAF) is also one of the goals of the Accreditation Body of Montenegro.

Conformity assessment

Conformity assessment in Montenegro is conducted in the manner which is aligned with the EU principles transposed through national horizontal technical legislation. All the principles of "global approach" have been transposed through the Law on Technical Requirements for Products and Assessment of Products Conformity with the Prescribed Requirements(Official Gazette of Montenegro 14/08), and through its secondary legislation The Decree on the Method and Procedures for Assessment of Products Conformity with the Prescribed Requirements (Official Gazette of Montenegro 71/08) , The Decree on the Procedure of Notification in the Area of Technical Regulations, Standards and Conformity Assessment Procedures (Official Gazette of Montenegro 55/08), The Decree on Conditions for Implementation of Technical Regulations of Other States and on Records of Foreign Documents on Conformity (Official Gazette of Montenegro 74/08).

Metrology.

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The Metrology Office of Montenegro makes the basis of the metrological system in Montenegro. The Metrology Office is an associate member of the WELMEC - the European Cooperation in Legal Metrology.

In the area of metrology, the new Law on Metrology is applied in Montenegro (Official Gazette of Montenegro 79/08), adopted in December 2008. The transitory and final provisions stipulate that regulations for implementation of the Law on Metrology should be adopted within two years as of the effective date of the Law. Secondary legislation adopted on the basis of the previously mentioned law is: Decree on the Legal Measurement Units (Official Gazette of Montenegro 22/09), The Rulebook on technical and metrological conditions and procedure for authorizing persons preparing water meters for verification (Official Gazette of Montenegro 44/09), Rulebook on technical and metrological requirements and procedure of authorizing persons for preparation of weight verification devices (Official Gazette of Montenegro 65/09), Rulebook on technical and metrological conditions and procedure for authorising persons preparing taximeters for verification (Official Gazette of Montenegro 74/09)

Main difficulties in The Metrology Office actually metrological system development are related to the adequate working space, metrological equipment and professional staff. Despite the financial crisis actually despite the limited funds Metrology Office intends to establish national laboratories for the basic physical dimensions: weight, length, volume, electrical dimensions, time and frequency and pressure. To this end acquisition of metrological equipment from the IPA 2007 fund will be significant. Parallel to the developing of the national laboratories activities on improvement of metrological infrastructure and legislative framework will be conducted.

Market Surveillance

On May 14, 2009 the Government adopted the Proposal Law on Amendments to the Law on Inspection Surveillance. Within the institutional framework for market surveillance in Montenegro, changes occurred in the area of phytosanitary and ecological surveillance. Namely, the Phytosanitary Administration has been formed, within which the Phytosanitary Inspection functions, and also, the Agency for Environment Protection has been formed, within which the Ecological Inspection operates.

Bylaws necessary for implementation of the Law on General Product Safety have been drafted. In the area of market surveillance carried out by Health and Sanitary Inspection, the following two laws have been adopted: Law on Health Inspection and Law on Medical Devices (Official Gazette of Montenegro 53/09). Market Surveillance Strategy of Montenegro, drafted by the inter-ministerial working party which was provided with the experts support under the TRIM MNE project, was adopted on Government session held on 5 November 2009.

Market surveillance and the need for the adoption of Strategy are the subject to the National Consumer protection Programe 2008 – 2010. National Consumer protection Programe envisages intentions for providing integrated surveillance primarily of technical and non-food market products in line with european standards which will be implemented through this Strategy.

Free movement of workers

The Law on Employment and Work of Foreigners (Official Gazette of Montenegro 22/08) came into force on 1 January 2009. It creates legal framework for movement of labour force and increased mobility and flexibility of foreign citizens’ access to labour market in

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Montenegro, for the purpose of balancing supply and demand in this market. According to this Law, the employed foreigner, with work permit in Montenegro, has equal rights as domicile employee.

Intellectual property

On 13 February 2009, the Government of Montenegro and the European Patent Organisation (EPO) signed an agreement on the extension of European Patents to Montenegro (so-called Extension Agreement) and the Law on Ratification of the Agreement on the extension of European Patents to Montenegro (so-called Extension Agreement) was published in Official Gazette of Montenegro 05/09 – section International Agreements.

Stamp Law, Law on Legal Protection Of Industrial Design and Law on Integrated Circuits Topography are in the Government procedure. Their adoption by the Parliament is expected in early 2010. Implementation of these laws does not require for the additional resources in the Budget of Montenegro and, due to fees, will affect the budget positively.

Information Society and Media

Electronic communication. Field of electronic communications is regulated under the provisions of the new Electronic Communications Law (Official Gazette of Montenegro 70/09). Under the provisions of the previously mentioned law Agency for Electronic Communications and Postal Services has been established. Agency for Electronic Communications and Postal Services disposes presently with a sufficient number of professional personnel with adequate qualifications for the performance of duties and competences laid down by the Law.

The Agency has initiated in 2009 significant activities concerning harmonization of the existing licenses with the new regulatory framework (brought into compliance with the European legislation in this field) as well as the procedure of market assessment and analysis and designation of operators having significant market power (SMP) pursuant to the Decision of the Agency’s Council, for 7 markets in line with the recommendation of the European Commission from 2007.

In the forthcoming period the Agency will initiate activities on additional market analysis which implies that the operators recognized as operators with significant market position even after such analysis will be subjected to the measures envisaged in the Law in the procedure envisaged by the Law.

Information society Subject to the Decree on Amendments to the Decree on Organization and the Manner of Work of the State Administration (Official Gazette of Montenegro 81/08) that came into force on 3 January 2009, the Ministry of Information Society has been established replacing the former Secretariat of Development. In February 2009, the Information Society Development Strategy of Montenegro has been adopted for the period of 2009-2013. The strategy sets guidelines for the development of a contemporary knowledge-based society and is designed to contribute to the effective implementation of electronic services to be used by both citizens and business undertakings.

Due to the limited budgetary funds the Ministry of Information Society will apply through the Community Program ICT-PSP for the funds needed for realization of the following projects: e-Montenegro centre, drafting of the national interoperability framework, safety and the implementation of the ISO 27001. The Ministry will continue with the activities on drafting the project „5-year National Strategy for Electronic Communications Development and

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Broadband Diffusion in Montenegro” with the meditation of the INA Academy - South-eastern Europe Telecommunications Academy and support of the Ministry of Foreign Affairs of Greece. Ministry for information society assumed the commitment amounting to 5% for co financing of this Project.

Media. The Parliament of Montenegro, at its session held on 17 December 2008, adopted the Law on Public Broadcasting Services of Montenegro (Official Gazette of Montenegro 79/08) that came into force on 1 January 2009. The Law defines precisely the obligations of the Radio and Television of Montenegro (RTCG) concerning the production and broadcasting of program contents as well as the obligations to adopt and adhere by professional standards and program rules. The broadcasting subscription and license fee for the use of radio sets in motor vehicles have been abolished. Subject to the new scheme of sources of funding, the RTCG shall be financed from the general revenues of the Montenegrin Budget. The funds needed for the accomplishment of the RTCG primary activity shall be allocated on the annual basis in the amount of 1.20% of the current Montenegrin Budget determined by the Budget Law for a specific year. Should the funds realized on the basis of excise taxes not be sufficient for the provision of the above mentioned amount, the lacking funds shall be provided from the revenues realized on the basis of value added taxes. The payment of funds shall be effectuated in the amount of 1/12 of the total designated funds, in the period of the 15th to 20th day of each month for the current month, pursuant to the decision of the Minister of Finance. The total amount of funds for financing the primary activity of the RTCG in 2009 is € 8,244,496.00.

Agriculture and Rural Development

The Law on Agriculture and Rural Development is the umbrella law, regulating the objectives and measures of agricultural policy, incentives, setting up of the payment agency, harmonization with the principles of the Common Agricultural policy, etc.

Activities significant for the institutional and administrative framework of agriculture and rural development are the following:

National Council for the Food Safety Assessment was formed thus completing the institutional structure in the field of food safety,

Under the provisions of the Decree on Amendments to the Decree on Organisation and the Methods of Work for the Public Administration (OGM 43/08), the Phyto-sanitary Administration was established. The Phyto-sanitary Administration commenced its activities in the fiscal 2009. Through the Twinning Project (IPA 2010) for which implementation 700 000 euros is provided by the European Commission and 70 000 euros by the national budget it is planned for Phyto-sanitary Administration to improve its administrative capacities in 2010 and 2011. Plant health protection activities are now combined under a single authority, which is in compliance with the Directive (Celex No. 32000L0029), which clearly defines setting up of a responsible official body in charge of phyto-sanitary issues.

In compliance with the new Law on Plant Protection Products (Official Gazette of Montenegro 51/08), the Department for Plant Protection Products and Residues was established and its role is to follow the residue monitoring programme for pesticides in the food of plant origin for 2009 (Official Gazette of Montenegro, 57/09) which is currently being implemented.

In April 2009, the twinning partner was selected – the Austrian-French-Slovak consortium – for implementation of IPA 2008 project Support to Establishing of IPARD Programming and Implementation System. In April 2009, the World Bank approved an 11 million Euros credit and a grant of 4 million USD from GEF funds for

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implementation of the project Institutional Development and Strengthening of Montenegro’s Agriculture, which will be used over the period of five years.

National Program for Integration of Montenegro into the EU envisages gradual employment of up to 20 persons in the Payment Agency (primarily IPARD Agency) for the instruments of financial aid that Montenegro is to use under IPARD funds. Bearing in mind the limitations imposed by the financial crisis and the restrictive Government policy in the area of additional employment, execution of previously mentioned obligations may be postponed. This relates to the realization of the Twinning project and its aim of establishing the IPARD structure, which implies new employees within the Ministry. In the course of 2010 and 2011, it is necessary to provide the adequate premises, facilities and IT equipment for initiation of the Agency’s work.

Statistics

In 2009 based on proposal of MONSTAT, Goverment of Montenegro has adopted Strategy on development of Statistics 2009 – 2012 and Statistical Survey Programme 2009-2013. Previously mentioned documents together with completed draft of the Proposal of the Law on Amendments to the Law on Statistics and Statistical System of Montenegro which is expected to be adopted in 2010 will create legislative framework of the official statistics aligned with international standards. Implementation of the adopted legal acts and methodological improvement of the official statistics will be supported through realization of the national project IPA 2007 in the period 2009 – 2011.

In 2009, Law on Agricultural Census was adopted, trial agriculture census was conducted and the methodology adopted, while the realisation of the census is planned for April 2010. During 2009 trial population census was conducted while the main population census is planned to be conducted in 2011. Law on Population Census is planned to be adopted in 2010.

Judiciary system

Monitoring of the implementation of goals defined by the Strategy for the Reform of the Judiciary (2007-2010) and the measures for the realisation of the strategic goals envisaged by the Action Plan is done in line with planned dynamics and supervised by a Commission for the Monitoring of the Implementation of the Action Plan and an Expert Team.

Human rights and protection of minorities

In course of 2008, the Minority Fund started to work. The Fund has a Steering Board and a Director. Total amount of funds for 2008 was € 422,150 while € 1,018,000 is planned for 2009. 2008 budgetary funds were provided for the work of constituted minority councils. Budget 2009 foresees € 360,000 for the work of the Council in 2009.

The implementation of the Strategy for the Improvement of the Position of the RAE Population in Montenegro, which was adopted in November 2007 for the period 2008-2012, has been continued. The 2009 Budget allocation is € 600,000 and certain education projects have already been started.

The Employment Office, in cooperation with the UNDP trained 12 RAE persons and awarded three € 6,000 grants which financed the employment of six persons. The UNDP funded the development of five education programmes.

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The Refugee Care and Support Office is still implementing the Assistance to RAE Newborns project through which every RAE newborn is awarded € 100. Total worth of this project is € 15,000. Currently, the preparations for the start of realisation of the project entitled Procurement of Three-Wheel Vehicles to RAE Population Eligible for Work are under way. Total worth of this project is € 16,000. Both projects have been funded by the Budget of Montenegro.

Justice, freedom and security

Visas The Government of Montenegro adopted on 26 February 2009 the Decree on the Visa Regime (Official Gazette of Montenegro 18/09), which came into force on 19 March 2009. This Decree harmonized visas regime of Montenegro with European standards

On the plenary session held on 12 November 2009, the European Parliament confirmed positive opinion on Draft Report of the Committee on Foreign Affairs by adopting Consultative Resolution. Council of Ministers of Justice and Home Affairs on its session held on 30 November 2009 adopted a positive Decision on visa abolishment for the citizens of Montenegro, Macedonia and Serbia. Visa abolishment decision came into force on 19 December 2009.

Asylum. Centre for Asylum Seekers, which is under the competence of the Refugee Care and Support Office, is still in the construction phase and it applies alternative solutions concerning the accommodation of the refugees. The Government approved € 450,000 for the completion of one of its parts through the capital Budget. The project for IPA 2009 support is approved. These funds will be allocated for the completion of construction and equipping of the Centre for Asylum Seekers.

Personal data protection. The Parliament adopted the Law on Amendments to the Law on Personal Data Protection which refers to defining five year mandate for the head and members of the Council of the Agency for the Personal Data. Article 59a stipulates the manner of establishing revenues of the head and members of the Council of the Agency.

Education and research

The Government adopted the Rulebook on the internal organization and job classification in the Ministry of Education and Science on 30 October 2008. New structure includes 4 Sectors, 5 Sections and 3 Services.

On 14 May 2009 the Government of Montenegro adopted the Decision on establishing the Council for the Adult Education (Official Gazette of Montenegro, 36/09), the Decision on establishing the Council for the General Education (Official Gazette of Montenegro, 36/09) and the Decision on establishing the Council for Professional Education (Official Gazette of Montenegro, 36/09).

In the Sector for science, research, and technological development, which was established in the Ministry after the adoption of the Rulebook on Internal organization and Job description of the Ministry of Education and Science, 7 employees were foreseen, and together with the Council for Scientific-Research Activities, this Sector deals with the issues of improving the scientific-research activities, analyzing the status and the achievements in the scientific-research activities, giving professional proposals to the Government, as well as with monitoring the implementation of the Strategy for Scientific-Research Activities in Montenegro (2008-2016).

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As a part of the further support to the scientific and research activities in Montenegro, the amount of € 141,485.00 was allocated as a part of the call for co-financing of scientific and research activities which was published in 2009.

Environment protection and spatial planning

In accordance with the new Rulebook on internal organization and systematization of the Ministry for spatial planning and environmental protection number of employees dealing with environmental protection is 46 and the number of employed persons in Environmental protection Agency according to the systematization act is 50 but currently working number of employees is 38. Work of the Environmental protection Agency is financed by budgetary funds and donations. Budget for 2009 (Official Gazette of Montenegro 31/09) foreseen 942,743.06 € for the work of the Agency.

In the framework of the Multibeneficary IPA, main goal of the Instrument for support to the infrastructure projects (Infrastructure Project Facility- IPP) is providing technical support for preparation of project documentation i.e. feasibility studies, elaborate on impact assessment etc, needed for realization of infrastructural projects as well as providing support for realization of concrete activities trough Municipal Window Programme which is recognized as a significant instrument of support to the national subjects in the field of environment. In 2008 approved funds for preparation of feasibility study and studies on environmental impact assessment for wastewater treatment facility in Podgorica amounted to 135,000 €. For 2009 approved funds for preparation of technical cooperation for wastewater treatment facility construction in Berane amounted to 150.000 € and trough the Municipal Window Programme non-refundable funds in total amount of 5 mil € were approved for Wastewater Treatment Facility Construction in Pljevlja, Bijelo Polje, Plav and Cetinje.

In March 2009 an Agreement on Loan between Montenegro (Ministry of Finance) and Instituto de Credito Oficial (ICO) of the Kingdom of Spain was signed. It envisages a Spanish loan to Montenegro of approximately € 5 million for funding a project entitled Regional Recycle Centre Construction in Livade – Podgorica. An important segment of the new system of spatial planning, established under the provisions of the Law on spatial planning and construction which defines organizational set up and assumptions for implementation of the state spatial planning, is preparation of the report on the spatial planning status as well as spatial planning programme.

Spatial planning programme is prepared on the basis of the report on the spatial planning status and it comprises assessment of needs for preparation of new or amending existing planning documents as well as significant measures for preparation and adoption of those documents. Spatial planning programme determins spatial planning dynamics, sources of financing, planning deadlines, operational measures for implementation of the planning document, especially measures for utility equipment of construction sites, etc.

As appropriate, Programme contains also the measures in accordance with assumed international committments in relation to the objects built contrary to the law. Spatial planning programme for 2010 contains significant number of planning documents which are underway, and defines drafting and adoption of new planning documents - this approach is based on the need for aligning the new concept of spatial development with the new manner of spatial planning pertinent with strategic development goals of the State.

Detailed spatial plan for Adriatic-ionic highway; Detailed spatial plan Adriatic MAGISTRALA for fast motor transport;

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Detailed spatial plan for small hydropower plants Detailed spatial plan for route of the new trunk and underwater cable Montenegro -

Italy Detailed spatial plan for the space of multifunctional acumulations on the river

Komarnica Spatial plan of special purpose for the Skadar lake region Spatial plan of special purpose for National Park Prokletije; Spatial plan for area of special purpose National Park ’’Lovćen’’ (amendments) or

other adequate planning document Spatial plan for area of special purpose Costal Managment (amendments), because

of the ratification of the Protocol on integral managment of costal area, State study of the location for Tivat airport Studies of locations for sites in the framework of Spatial plan for the area of special

purpose for Costal Managment will be determined aftherwards depending on expressed needs and priorities.

Studies of locations for sites in the framework of spatial plans for area of special purpose for national parks will be determined aftherwards depending on expressed needs and priorities.

Consumer and health protection

In 2009 Commission for monitoring of the implementation of the National Programme for Consumer Protection was formed with its main goal of monitoring the implementation of the National Programme for consumer Protection. Establishment of this working body is legally based on the decision of the Ministry for Economic development as of 2 July 2009 according to the Government conclusion as of 23 April 2009, and it is consisted of 15 members. All the institutions whose representatives are members of the Commission are obliged to pay compensation for their work. The new Law on Consumer Protection, which is planned to be adopted in 2010, will promote the Consumer Protection Council as a consultative body.

Urgent Medical Office was established in July 2009 under the provisions of the Law on Urgent Medical Aid (Official Gazette of Montenegro 49/08) and on the basis of the Law on Blood Supply (Official Gazette of Montenegro 11/07), Blood Transfusion Institute was established in October 2009.

Foreign affairs, security and defense

On 27 November 2008 the Government of Montenegro has adopted the Rulebook on Internal Organization and Job Description of the Directorate for Protection of Classified Data, which establishes three organizational units within the Directorate: Department for Protection of Classified Data, INFOSEC and General Affairs and Finances Service, with total of 14 employees. Currently there are 5 employees in the Directorate.

Pre-accession funds – establishing of decentralized implementation system

The adoption of the Information on Phase II of Establishing DIS in Montenegro on 15 January 2009 followed after the adoption of the Information on Establishing of Decentralized Implementation System (DIS) in Montenegro, which represented the official commencement (2008) of the overall process of establishing structures required for functioning of the system. The adopted Information that represents the continuation of fulfilling of requirements for obtaining accreditation, defines the relation between the National IPA Coordinator (NIPAC) and National Authorizing Officer (NAO) as the main bearers of the DIS establishment

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process, and confirms the appointment of key actors in using the EU assistance. The Committee for Coordination of IPA programs has been established.

NAO as the head of the National Fund (NF) is responsible for the overall financial management of the EU assistance. According to the Rulebook on Internal Organisation and Systematisation of the Ministry of Finance adopted in March 2009 the National Fund is defined as a section within the State Treasury Department with 5 staff. Also, the reorganisation of the current Central Financing and Contracting Unit (CFCU) managed by the Program Authorising Officer (PAO) is mentioned as one of important items. Under the new Rulebook, the unit gains the status of a department titled as Department for Financing and Contracting EU Assistance Funds, with 9 staff.

The Action Plan for conferral of management powers for IPA funds including corresponding activities to be implemented in 2009 was adopted at the meeting of the Government of Montenegro held on 15 January 2009. With regard to programming and implementing of projects from IPA component I, Senior Programming Officers – SPO have been appointed in line ministries, while the establishing of the Project Implementation Unit (PIU) is in process.

In order to be able to implement the above mentioned activities the key DIS bodies are provided with expert assistance through the project “First Steps for a Decentralised Implementation System (DIS) in Montenegro” (no. 06MON01/11/001) funded from the national CARDS program 2006 and implemented by the consulting agency EWC (East West Consulting). The main beneficiaries of the project budgeted in the amount of 499000 euro that commenced in September 2008 and completed at the end of December 2009 were the Ministry of Finance and the Ministry for European Integration. The drafting of the Manual of Procedures is in process for decentralized implementation system (DIS) structures of the Instrument for pre-accession assistance (IPA), as a document of horizontal character, since it will relate to all management levels and will be used for both IPA components accessible to Montenegro.

In December 2009, the Government adopted the first Information and an indicative Action Plan for use of IPA components III and IV (regional development and human resources development), which defines operational structures and the work plan on preparation of the key documents in this area.

The progress in this process in relation to the plans defined in the previous EFP may be viewed at based on the assessment by the representatives of the European Commission (EC) of the Enlargement Directorate during the fact-finding mission in respect of identifying results achieved in the process of establishing DIS in Montenegro, in May 2009. Namely, according to the Roadmap for decentralised IPA funds management (an EC document), every country must be subject to 5 phases on the road to accreditation for DIS. EC auditors are of the opinion that Montenegro has made significant progress in achieving the establishment of DIS, and have concluded that it is still in the zero phase - Establishment of the Management and Control System and it is necessary to have a formal Gap assessment phase carried out by an independent audit firm. The gap assessment phase that represents the base for implementation of the following phase commenced in November 2009, while the final Report that is to include the relevant assessments and recommendations, for both components individually, is expected in February 2010. In addition, auditors demanded the current Action Plan (adopted by the Government in January 2009) to be reviewed and adjusted to the EC Roadmap phases. This demand has been met through a new Information adopted by the Government on 15 October 2009, with updated Action Plan for Conferring Management Powers for IPA components I and II, which includes all the phases of the EC Roadmap and simultaneously represents the National Roadmap.

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Depending on the audit assessment, the following phase of compliance, i.e. preparation for decentralized management (gap plugging) will commence, with the aim to eliminate the flaws identified in the previous phase. It is envisaged that the mentioned phase will last until 1 August 2010 which will enable the plugging of the gap between the actual and required status based on the identified flaws and recommendations given in the Gap Assessment Report.

The following third phase, i.e. Compliance Assessment is related to the engagement of an independent audit firm by national authorities in order to verify the readiness of established DIS structures to be awarded the national accreditation. The process itself is planned in the way that the Competent Accrediting Officer-CAO should sign a contract with a selected independent audit firm that is to carry out this process. The audit firm with which the contract has been signed will produce the Report, which will include their opinion with regard to awarding of the national accreditation. Based on a positive opinion of the independent audit firm, incorporated in the Compliance Assessment Report, CAO will accredit the National Fund, i.e. NAO, and the NAO will accredit the operational structure, i.e. PAO, which makes the fourth phase, i.e. National Accreditation and Submission of Application for Conferral of Management. Afterwards, NAO will, along with the application for conferral of management of EU funds, submit to the European Commission the Accreditation Package that is to include the documentation on accreditation of the Operational Structure, as well as any required additional information that the European Commission might require. It is envisaged that the phase of obtaining the national accreditation should last until 1 February 2011.

Unlike previous phases that represent an obligation of the countries that are beneficiaries of funds, the last, fifth phase - Preparation for Commission Decision is exclusively an obligation of the EC and usually takes to 6 months.

In the subsequent period it is necessary to undertake a range of activities as to confer powers for management of programs and projects, from the EC to the EU assistance beneficiary country, i.e. Montenegro. This implies the following:

-Establishing of an Audit Authority, that will be responsible for verification of effective and stable functioning of the management and control system. To that end the Memorandum of Understanding has been produced between the Government of Montenegro and the State Audit Institution (SAI), which should be signed by the Competent Accrediting Officer-CAO, on behalf of the Government of Montenegro, and the president of the Senate of SAI. After the establishment of this body, the appointment of the Audit Authority managers and recruitment of staff will commence.

-Within IPA component II, as planned by the current Action Plan, it is necessary to establish mechanisms that will enable the segregation of duties among the actors making the Operational Structure for IPA component II in the form of an operational agreement that is to be executed by the representatives of the Ministry for European Integration (Department for Cross-Border Cooperation Programs) and PAO.

For elimination of the flaws identified in the gap assessment phase and fulfilment of other accreditation requirements, DIS bodies will be provided with expert assistance through the project ’’Strengthening the management and control systems for EU financial assistance in Montenegro’’, funded from IPA 2009. The project will be related to components 1 and 2, as well as the components 3 and 4.

Since the European Union is providing support to Montenegro on its way to membership, every year it will allocate significant financial support, defined in the strategic European and national documents, within which a country applies for certain projects, the amount of which will be allocated depending on the quality of proposed projects. In addition to foreign support, it is necessary to provide some funds from the national budget to support the

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activities of the employees in established structures. The review of financial requirements for establishing of DIS is given in the following Table. Namely, with regard to financial requirements related to CFCU, as a part of the operational structure for components I and II, the estimated funds amount to 85,915 euro in 2009, while for the period from 2010 to 2012 the amount increases, in accordance with the increase of the number of staff and scope of activities, since it is envisaged that in this period the CFCU will be a part of the operational structure for components III and IV. With regard to the National Fund, which was established within the Treasury Department in the Ministry of Finance in 2009, financial resources are estimated in the amount of 24,524 euro, while for the period from 2010 to 2012 the amount of funds will increase since the NF will be responsible for all five IPA components. Senior programming officers (SPO) in all line ministries are responsible only for IPA component I, and estimated funds in 2009 amount to 588,480 euro, while in the period from 2010 to 2012 the amount is expected to be higher due to the increase of the number of staff.

Table 31: Financial requirements for establishing of DIS

2009. 2010. 2011. 2012.

Budget

CFCU – Operational structure for components I and II 85.915 183.815 232.826 232.826

MF – National Fund (Treasury Department) for components I, II, III, IV and V 24.524 61.310 61.310 61.310

SPO – Senior Programming Officers of all ministries for component I 588.480 784.640 784.640 784.640

Foreign assistance 500.00027 2.300 00028

Source: Ministry of Finance, Budget Department

The level of use of these funds will depend on the manner and readiness of the assistance beneficiary country to spend the allocated funds. This rule is valid irrespective whether the system for management of pre-accession funds is centralized (as is the current condition) or decentralized (that is to be established after the accreditation criteria prescribed by the EU have been met). Here it needs to be pointed out that once adequate institutions have been established, which are ready to absorb the resources from pre-accession funds, the beneficiary country will be concurrently prepared for use of significantly higher amount of resources from Structural and Cohesion funds on the day it becomes a member of the European Union.

27 The amount was provided from the CARDS Project 2006 “First Steps for a Decentralised Implementation System (DIS) in Montenegro”.

28 The amount was provided from the IPA Project 2009 “Strengthening the management and control systems for EU financial assistance in Montenegro”, which duration is 24 months.

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