IMF Wraps Up 2024 Kosovo Economic Review and Talks

• The IMF Executive Board concluded the 2024 Article IV Consultation and the Third Reviews under the Stand-By (SBA) and the Resilience and Sustainability Facility (RSF) arrangements with Kosovo. This provides Kosovo access to an additional SDR 13.35 million (€16.7 million) under the SBA and SDR 15.5 million (€19.3 million) under the RSF.
• Kosovo's economic performance has been strong, with growth accelerating in 2024 and inflation falling sharply. The near-term outlook is favorable despite some downside risks.
• The authorities continue to show strong performance under both programs. All quantitative targets and structural conditions for the completion of the Third Review under the SBA were met. Most RSF Reform Measures (RMs) have been completed.

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the 2024 Article IV Consultation ^[1] and the Third Reviews under the Stand-By (SBA) and the Resilience and Sustainability Facility (RSF) arrangements with Kosovo on a lapse-of-time basis. ^[2] The completion of the Reviews allows the authorities to draw SDR 13.35 million (€16.7 million) under the SBA and SDR 15.5 million (€19.3 million) under the RSF. This would bring total disbursements under the RSF to SDR 54.21 million (€67.7 million). The authorities continue to treat the SBA resources precautionary.

Kosovo's economy continues its robust performance. Supported by strong private consumption and a positive contribution from public investments, growth in 2024 is now expected to reach 4¼ percent. Inflation has rapidly decelerated—owing to slowing food and transportation services inflation—and is now expected to be at 1.8 percent on average for 2024. The external current account deficit is expected to widen in 2024 fueled by higher domestic demand, including due to strong private sector credit growth. The banking sector remains healthy—profitable and well-capitalized with low levels of non-performing loans. Growth in 2025 and over the medium term is expected to converge towards potential—around 4 percent, while inflation is forecast to remain around the ECB's 2 percent target. Downside risks to the outlook stem from higher commodity prices and a slowdown in advanced European economies. On the other hand, faster integration with the EU could provide important financing and boost reform momentum.

Performance under both arrangements has been strong. All end-June 2024 quantitative performance criteria (QPCs) and indicative targets (ITs) have been met. All ITs for end-September were also met.

A structural benchmark (SB) for end-June and a prior action on the submission of the 2025 budget in line with program commitments have also been met. Most reform measures agreed under the RSF have been implemented.

Executive Board Assessment

Activity has accelerated and inflation has receded rapidly, but structural vulnerabilities remain. Growth increased in 2024, supported by strong private consumption and rapidly declining inflation that boosted real incomes. However, the external balance has deteriorated with a widening trade deficit and lower remittances. Growth is expected to reach 4¼ percent in 2024 and stabilize around 4 percent in the medium term, while inflation will converge to the ECB's 2 percent target. Given the large investment needed to further accelerate growth to converge towards EU income levels, Kosovo should increase investments and the labor supply, while boosting competitiveness and diversifying exports.

Program performance has been strong. All QPCs and ITs for the Third Review of the SBA were met. ITs for September were also met. SBA structural conditionality and all but one RSF RMs were implemented, with RM2 on launching a wind power auction still pending. Policies required for the next reviews are progressing. Given expected financing flows for 2024–25, the authorities intend to continue treating the SBA as precautionary, but they may purchase if an adverse shock or shortfall in financing materializes. The SBA has anchored fiscal policies and supporting measures to increase fiscal transparency and accountability, such as the reduction of budgetary contingency reserves and dissemination of POE financial information. In the financial sector, the CBK is making strong progress on institutional and governance reforms, including regulating NBFIs and digital payments. The RSF is delivering tangible results in support of the authorities' ambitious green reforms. The recent auction for 100 MW of photovoltaic energy and the progress with announcing the 150 MW wind energy auction are testimony to progress increasing contributions of renewables in the energy mix. The authorities have proposed two new SBs for the Fourth Review of the SBA.

Fiscal policy should continue to balance sustainability and development objectives and be framed within a solid, rules-based fiscal framework. The 2025 budget envisages a fiscal impulse with full-year implementation of spending measures announced in 2024, a proposed increase in public wages, and the expected improvement in public investment execution. The increase of the deficit is consistent with Kosovo's fiscal rules and takes place against the backdrop of a disinflation, low debt, and overperformance vis-à-vis 2023–24 program fiscal targets. The program is fully financed with firm commitments in place for the remainder of the program. Reforms of the institutional fiscal framework are under preparation seeking consistency with EU approaches and striking a balance between fiscal prudence and the need for flexibility and growth-enhancing policies. Further strengthening tax capacity is crucial to provide fiscal space for priority social and capital spending.

Rapid credit growth calls for strong financial sector oversight, and reforms to upgrade regulatory framework, crisis preparedness and CBK governance should continue. While financial deepening resulting from the expansion in domestic credit can better support economic development, the CBK should watch for emergence of any potential risk. While implementation of 2019 FSSR recommendations has progressed well, further efforts are needed to modernize the banking sector regulatory framework, strengthen surveillance of housing, microfinance, and non-bank financial institutions, and reinforce the financial safety net and resolution system. The transition to a more modern banking supervision framework will require sufficient time for thorough preparation. The CBK should also review the phasing of new macroprudential requirements on capital adequacy.

The authorities should continue building buffers against possible shocks. Such shocks could arise from financial sector liquidity shortages or from volatility in government accounts. In case of adverse shocks, the CBK could provide liquidity support by deploying emergency liquidity assistance funds and the current repo line with the ECB. Readily-available Treasury deposits at the CBK would provide an additional cushion against such shocks. Still, staff analysis suggests that these deposits could be increased to provide greater insurance. Staff's most recent assessment suggests that the external position is weaker than the level implied by fundamentals and desirable policies. Gross international reserves stood at 92 percent of the IMF's reserve adequacy metric in 2023, and at 91 percent in September 2024.

Implementing comprehensive governance reforms is critical to boost growth potential. Anti-corruption and governance reforms reduce resource misallocation and improve the business environment, fostering inclusive growth. Milestones have been achieved in judiciary reform, but more is needed, particularly to promote alternative resolution schemes. On fiscal governance, a more holistic approach to budget execution would be welcome. Continuing application of transparency practices implemented under the program is recommended, particularly in reporting final uses of unallocated budget reserves.

Structural reforms are urgently needed to raise potential growth. Priority should be given to further advancing green reforms and decarbonization, implementing policies to boost female labor-force participation, attracting foreign capital—including from the diaspora—into productive sectors of the economy, and accelerating digitalization. While a national development bank could enhance access to finance, its establishment requires thorough analysis of benefits and costs and rigorous governance and operational provisions. Reducing informality is crucial to increase the number of pension trust (KPST) contributors and raise domestic savings. KPST should continue improving its investment practices to enhance returns and promote saving.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.