BANKING (last name T-Sh)

1. The banking sector and the investment banking in Macedonia 2. Investing in development the Macedonian case

FYR of Macedonia Investment Climate

26 January 2010 by Ina Dimireva -- last modified 26 January 2010 As a small, open economy, the FYR of Macedonia continues to take active steps to attract foreign direct investment (FDI). The country has enacted legislation that not only ensures an equal footing for foreign investors vis--vis their domestic counterparts, but also provides numerous incentives to attract such investment. Even before gaining full membership in the World Trade Organization (WTO) in April 2003, Macedonia consistently provided national treatment to foreign investors. The country has concluded a number of bilateral investment protection treaties and other multilateral conventions that impose stricter protection standards for foreign investors. Openness to Foreign Investment As a small, open economy, Macedonia continues to take active steps to attract foreign direct investment (FDI). The country has enacted legislation that not only ensures an equal footing for foreign investors vis--vis their domestic counterparts, but also provides numerous incentives to attract such investment. Even before gaining full membership in the World Trade Organization (WTO) in April 2003, Macedonia consistently provided national treatment to foreign investors. The country has concluded a number of bilateral investment protection treaties and other multilateral conventions that impose stricter protection standards for foreign investors. The Constitution of Macedonia, as the supreme law of the land, guarantees the equal position of all entities in the market, and provides for free transfer and repatriation of investment capital and profits for foreign investors. Macedonia's privatization process is almost complete. Under Macedonian law, foreign and domestic investors have

equal opportunities to participate in the privatization of remaining state-owned capital. There is no single law regulating foreign investments. Rather, the legal framework is comprised of several laws, including: the Trade Companies Law; Securities Law; Profit Tax Law; Customs Law; VAT Law; Law on Trade; Law on Acquiring Shareholding Companies; Foreign Exchange Operations Law; Payment Operations Law; Law on Foreign Loan Relations; Law on Privatization of State-owned Capital; Law on Investment Funds; and the Banking Law. The legal system in Macedonia is undergoing substantial reform. However, it is still often slow, inefficient, lacking in adequate resources, and sometimes subject to political pressures and corruption. Enforcement of the law and upholding of contracts is inconsistent and not always impartial. The Trade Companies Law This is the primary law regulating business activity in Macedonia. It defines the types of companies allowed to operate in Macedonia, as well as procedures and regulations for their establishment and operation. As all foreign investors are granted national treatment, they are entitled to establish and operate all types of private or joint-stock companies. Foreign investors are not required to obtain special permission from state-authorized institutions other than what is customarily required by law. Law on Privatization of State-owned Capital According to this law, foreign investors are guaranteed equal rights with domestic investors when bidding on tenders for company share packages owned by the government. There are no impediments to foreign investors participating in the privatization process of domestic companies. Foreign Loan Relations Law This law regulates the credit relations of domestic entities with those abroad. Specifically, it regulates the terms by which foreign investors can convert their claims into deposits, shares or equity investment with the debtor company or bank. The Foreign Loan Relations Law also enables rescheduled debt to be converted into foreign investment in certain sectors or in secondary capital markets. Law on Investment Funds A new Law on Investment Funds is expected to replace the existing one in 2008. Until then, the current law governs the conditions for incorporation of investment funds and investment fund management companies, the manner and supervisory control of their operations, and the process of selection of a depository bank. The law does not discriminate against foreign investors in establishing open-ended or closed investment funds. Law on Foreign Exchange Operations This law establishes the terms for further liberalization of capital transactions. It regulates current and capital transactions between residents and non-residents, the transfer of funds across borders, as well as all foreign exchange operations. All current transactions of foreign entities are allowed. There are no restrictions for nonresidents to invest in Macedonia. Foreign investors may repatriate both profits and funds acquired by selling shares after paying regular taxes and social contributions. In case of expropriation, foreign investors have the right to choose

their preferred form of reimbursement. While they themselves cannot directly own land, foreign investors may invest in or own fixed assets and real estate. Foreign investors may also establish domestic companies that have the right to purchase land. Profit Tax Law Starting in January 2007, the profit tax was reduced from 15 percent to 12 percent. On January 1, 2008, the rate was further reduced to 10 percent. At the beginning of 2006, the GOM amended the Profit Tax Law and introduced a withholding tax on income for foreign legal entities. The withholding tax is applied to income from dividends, interest, management consulting, financial, technical, administrative, research and development services, leasing of assets, awards, insurance premiums, telecommunication services, authors fees, and sports and entertainment activities. Income from all of these activities is subject to a 15 percent withholding tax rate, except for income from interest and leasing of real estate, which are taxed at a 10 percent rate. This withholding tax does not apply to legal entities from countries which have signed an agreement for avoiding double taxation with Macedonia. The USA and Macedonia have not yet signed such an agreement. Other Legal Considerations Foreign investment may be in the form of money, equipment, or raw materials. According to the law, foreign investors have the right to receive the full value of their investment in the case of nationalization. This regulation offers an additional incentive to foreign investors, since it is not offered to national investors. The privatization process is governed by the Law on Transformation of Enterprises with Social Capital (Official Gazette 38/93) and the Law on Privatization of State-owned Capital (Official Gazette 37/96). To finalize the privatization of remaining loss-making and bankrupted state companies, the government offered large discounts on the nominal value of the shares and did not impose employment and investment requirements. Except for the power distribution company, all other state-owned utilities are yet to be privatized. Foreign investors are allowed to invest directly in all industry and business sectors except those limited by law. Investment in the production of weaponry and narcotics is prohibited without government approval. Investors in some sectors, such as banking, financial services, and insurance, must meet certain licensing requirements that apply equally to domestic and foreign investors. Conversion and Transfer Policies Macedonias national currency, the denar (MKD), while fully convertible within the domestic market, is not convertible on foreign exchange markets. Conversion of most foreign currencies is possible on the official foreign exchange market. In addition to banks and savings institutions, numerous authorized exchange offices also provide exchange services. The National Bank operates the foreign exchange market, but participates on an equal basis with other entities. Required foreign currency reserves are spelled out in the banking law. There are no restrictions on the purchase of foreign currency by residents. Parallel foreign exchange markets do not exist in Macedonia due to the long-term stability of the denar. The National Bank's strategy is to maintain a stable exchange rate by pegging the denar to the Euro and keeping inflation low.

The Constitution of Macedonia guarantees the free transfer and repatriation of investment capital and profits. By law, foreign investors are entitled to transfer profits and income without being subject to a transfer tax. Investment returns are generally remitted within the international standard of three working days. Expropriation and Compensation According to the Constitution of Macedonia and the Law on Expropriation (Official Gazette 33/95, amended Official Gazette 20/98, and 40/99), foreign ownership is exempt from expropriation except during instances of war or natural disaster, or for reasons of public interest. Public interest, as defined by this Law, includes the following:

Construction of infrastructure; Construction of power stations, waterworks, water supply systems, postal and communication systems and

all accompanying and supporting infrastructure;

Construction of buildings for defense and civil protection and regulation of border crossings; Buildings and equipment for research of natural resources, education, science, health, culture, social

security, athletics or activities; and

Building settlements following extreme natural disasters and relocation settlements.

The beneficiary of expropriation is the state, especially when it allocates finances for public service, public enterprise, public funding and local government units. Under the Law on Expropriation, the state is obliged to pay market value for any property expropriated. If the payment is not made within 15 days of the decision brought for expropriation, default interest will be calculated. There have been no expropriation measures taken since the 1950s, nor is there any reason to believe the government will take such action in the future. The government does not impose confiscation taxes of any kind. In 2002, under the Law on Denationalization, the government pursued an ambitious plan for returning or providing compensation for nationalized property. In 2007, it revived the project by extending another deadline, until the end of 2007, for receiving denationalization claims. Claimants filed a total of about 25,000 claims, out of which 16,200 were positively resolved. About 11,500 cases have been finalized and effectuated, i.e. property was either returned or owners were adequately compensated. Dispute Settlement Under Macedonian law, arbitration of international disputes is distinct from that of domestic disputes. The parties involved in an international dispute may agree to settle through domestic litigation (Official Gazette Number 79/05; September 21, 2005), through mediation (Law on Mediation; Official Gazette 60/06; May 15, 2006), or foreign arbitration tribunal (Official Gazette Number 39/06; March 03, 2006). Ratified international agreements trump domestic legislation. International arbitration is recognized and accepted as valid by government regulation. The government accepts binding international arbitration on investment disputes and has over 40 internationally-accredited arbiters on the

countrys arbitration list. The arbitration court applies the appropriate law based on issues determined by the parties. In the event that the parties cannot agree on the issues involved in the case, the court then makes its own assessment of the merits of the case. International sources of arbitration law consist of bilateral and multilateral conventions, which Macedonia has signed or inherited from the former Yugoslavia on the basis of succession. Macedonia has signed the Convention Establishing the Multilateral Investment Guarantee Agency (MIGA), the New York Convention of 1958 (governing the recognition and enforcement of foreign arbitral awards), and the Geneva Convention on the Execution of Foreign Arbitral Awards. Macedonia is also a party to the Washington Convention on the Settlement of Investment Disputes between States and Nationals of Other States, and the European Convention on International Commercial Arbitration. Furthermore, Parliament has instituted legislative changes to administer laws related to foreign investment. With the 1995 enactment of the Law on Courts, the judicial body evolved into a three-tiered court system: the Basic Court (or Court of the First Instance), the Appellate Courts and the Supreme Court. As of 2007, there is also an Administrative Court for handling administrative law cases. Also, in order to provide better resolution of business disputes and improve the business environment through the use of mediation, the Economic Chamber of Macedonia has signed a memorandum of cooperation with the Alternative Dispute Resolution Program of the World Banks International Finance Corporation. The agreement is part of an effort by Macedonia to introduce the use of the mediation in the business sphere. Performance Requirements and Incentives Both the Law on Customs and Law on Profit Taxes offer incentives to foreign investors. Foreign investors are eligible for profit tax exemptions in four areas:

Profits generated during the first three years of operation, in proportion to the amount of foreign investment; All profits reinvested in the company (starting January 1, 2008); Profits invested in environmental protection; and Profits invested in "underdeveloped" regions.

The government amended profit tax law entered into force January 1, 2007. Companies with at least 20 percent foreign capital are exempt from customs duties for the first three years after registration. Foreign investors are not required to purchase from local sources or to export all of their production. There are also no requirements for the government to be a partner in an enterprise. Commercial agreements determine which entity retains control over the investment revenue. Furthermore, there are no requirements for reducing foreign equity over time or for transferring technology.

With the beginning of 2008, a flat tax for the corporate and personal income with a 10 percent rate was introduced. The previous personal income tax rates amounted to 15, 18 and 24 percent, whereas the profit tax rates amounted to 15 percent. Geography plays an important role in determining investment incentives. The government places an emphasis on building in underdeveloped regions, and offers tax deductions as an incentive to develop, for example, in mountainous territory, border zones or rural regions. Macedonias government has no objections to accepting international monetary assistance or counsel from leading experts in sectors such as the economy, law, and education. When Macedonia receives foreign credit, the government is required to inform the parliament. Once informed, members of parliament decide whether the credit will be accepted. The government may, however, accept donations and irrevocable assistance without consulting with the parliament. The Law on Residency of Foreign Citizens sets requirements for both working and resident visas. There are some non-discriminatory limitations on obtaining a visa. A foreign citizen working in Macedonia can be issued a multiple entry visa. An employer should apply to the Employment Bureau to obtain a work permit for any foreign employees working in Macedonia on a temporary or permanent basis. There is no discriminatory export or import policy affecting foreign investors. Almost 96 percent of total trade (export/import) is unrestricted, with some exceptions for textile products. Current tariffs and other customs-related information are published on the Customs website. Right to Private Ownership and Establishment Under Article 30 of the Constitution of Macedonia, the investor's right to own property is guaranteed. Foreign investors may acquire property rights for buildings and rights for other immovable assets to be used for their business activities. They may acquire residential property, but not ownership rights over construction land. Foreign investors are permitted to have only land-use rights, not land ownership rights. Foreign investors may establish a domestic company, which has the right to purchase land. Ownership of property requires preservation of specific rights that serve both the individual and the community. For example, no person may be deprived of his/her property or the rights deriving from it unless the use of that property affects the general welfare of the public. If the property is expropriated or restricted, rightful compensation based on its market value is guaranteed. At the end of 1999, the government introduced two laws governing competition, a law on restricted competition and an anti-monopoly law. Macedonia still lacks a fair competition law, however. Under current law, state enterprises enjoy special privileges vis--vis their private counterparts. This is an area of concern for the countrys judicial system; it is not yet clear how Macedonia will address this issue. Under Macedonian law, foreign and domestic private enterprises have the right to establish and own business enterprises, engage in all forms of business activity, and freely establish, acquire, and dispose of interests in business activities. Protection of Property Rights

While the legal basis for protection of ownership of both movable and real property exists, implementation remains incomplete. In order to improve the registration of real estate through the Government cadastre system, the Government in 2006, prepared a two-year action plan for reform of the cadastre. The first step involved creating a new electronic service that should increase security and speed in real-estate transactions of the citizens, as well as opening an information line for foreign investors and domestic businesses that should shorten the time for providing property information. Intellectual Property Rights are covered by the Law on Industrial Property, enacted in 2002 and amended in 2006; the Law for Authors and Common Rights, enacted in 1995 and amended in 2005; and the Law on Customs Measures for Protection of IPR, enacted in 2006. The State Institute for Industrial Property governs patents, trademarks, service marks, designs, models and samples. The protection of author's rights (music, film and television, books, software, etc.) is administered by the Inspection Service within the Ministry of Culture, established in 1999. In addition, the State Market Inspectorate is responsible for monitoring and controlling establishments that sell or rent counterfeited or pirated goods. The Ministry of Interior also enforces the sale of intellectual property, as it relates to significant organized crime cases. Under the Law on Customs Measures for Protection of IPR, which went into force on January 1, 2006, the Customs Administration has enhanced authority to investigate cases of counterfeit goods, and has the right to seize suspect goods. The penalties for IPR infringement depend on the seriousness of the violation. In order of severity, the penalties can include: 30 - 60 days closure of businesses caught selling counterfeited or pirated goods, monetary fines of up to 5,000 euros, or prison sentence up to 5 years. IPR cases are not handled by specialized courts. Macedonia joined the World Intellectual Property Organization (WIPO) in 1993, and in 1994 became a member of the Permanent Committee of Industrial Property Protection Information of WIPO. As a successor to the former Socialist Federal Republic of Yugoslavia, Macedonia is a party to international conventions and agreements that the former Yugoslavia signed prior to Macedonias independence. Macedonias accession to the WTO in April 2003 underscored the urgent need for the government to prevent copyright infringement. The first step in that direction was taken in 2002 when the Government reached an agreement with Microsoft to legalize all government software. Over the past few years the Government has seized and destroyed some counterfeit items and taken some legal actions against those who produce and sell counterfeit goods. Nevertheless, overall enforcement remains weak, and counterfeit goods remain common in shops and markets in Macedonia. As an EU candidate country, Macedonia is obliged to harmonize its IPR laws and regulations with EU standards, and to demonstrate adequate enforcement of those laws. The Governments Secretariat for European Affairs is coordinating this effort. Transparency of Regulatory System There are no laws, policies, or legal regulations that formally would impede foreign investment in Macedonia. On the contrary, the government seeks to increase the level of foreign investment by enacting legal provisions (i.e. tax

incentives) favorable to investors. Such provisions notwithstanding, excessive bureaucratic red tape still poses difficulties in all spheres of government administration, providing opportunities for corruption and dragging out some administrative processes. In order to ease the regulatory burden, through a process dubbed the regulatory guillotine, the Government has reviewed business regulations with the intent to eliminate unnecessary and outdated regulations. As a result of the process, and in consultation with the business community and non-governmental organizations, the Commission for Regulatory Reforms has proposed changes to a number of laws to increase the ease of doing business in Macedonia. The Government claims that over 50 percent of existing administrative procedures were eliminated, or the time required to comply with them was reduced by half. In October 2007, the World Bank rated Macedonia in the Doing Business 2008 report as the fourth most improved state in terms of economical reforms, out of 178 countries. The improvement was due in part to a more efficient regulatory regime. Efficient Capital Markets and Portfolio Investment There are no legal barriers to the free flow of financial resources and portfolio investments. Financial resources are almost entirely managed through the Macedonian banking system. In 2007, foreign capital was present in 17 out of a total of 19 banks, and was dominant in 10 banks. Officially, at the end of the first half of 2007, foreign investors share in total banking assets grew by 6.9 percentage points, to 63 percent. According to the Central Bank, at the end of June 2007 the percentage of non-performing loans in the total credit portfolio of the banking system was 6.4 percent. Supervisory monitoring has been further strengthened, enhancing depositors' confidence. Banks enjoy high liquidity but a relatively low intermediation rate. Credit is available on the local market and allocated on market terms. Retail interest rates in 2007 remained at the level of the previous year, ranging between 6 and 24 percent, depending on the type of loan and the banks policy. The weighted average lending rate of the banking system at the end of October 2007 was 10 percent, while the deposit rate was 5.1 percent. Domestic companies secure financing primarily from cash flow, due to lack of corporate bonds or securities as alternative credit instruments. Because of the scarcity of private financing, credit demand is high, affecting interest rates. The leasing market expanded in 2007 as more leasing companies entered the market, but that market is still relatively small. Although showing significant improvement, Macedonias securities markets are still modest in turnover and capitalization. The establishment of a Stock Exchange in 1995 made it possible to regulate portfolio investments. On March 28, 1996, the commencement of trading operations created a central marketplace for securities trading. This was also the first organized stock exchange in the history of the country. Until 2005, activity on the stock market was extremely limited, but the offer of shares from well-established companies in 2005 attracted both domestic and foreign investors. The Securities and Exchange Commission regulates Macedonias securities market. The number of companies listed on the Official Market increased in 2006 and in 2007. Trading picked up, especially in the first half of 2007, although most of the activity still takes place on the Secondary Market, where less transparency and more limited disclosures are required. Foreign investment funds were the driving force of the higher turnover and increased trading in 2007. The lack of domestic investment funds caused individuals to buy and sell stocks on the Macedonian Stock Exchange on their own, rather than through an investment fund. Individual investors therefore accounted for up

to 40 percent of the total turnover of the stock exchange. Government paper is present on the stock exchange in the form of denationalization bonds, frozen foreign currency bonds and a few special purpose bonds. In January 2004, the government started issuing treasury bills, and has diversified the terms of maturity, striving to move to longer-term bills. Other government-issued bonds are for frozen foreign currency deposits and denationalization. A fully convertible current account puts no restrictions on portfolio investments, but short-term capital inflows are still relatively low. Full liberalization of the capital account, allowing Macedonians to open foreign bank accounts from Macedonia, is expected in the second half of 2008. Macedonia has no regulatory defense measures directed against foreign investment. Similarly, there are no private or government efforts directed toward restricting foreign entities from investment, participation, or control of domestic enterprises, consortia or industrial organizations. On the contrary, the GOM in 2007 launched an expansive campaign to attract foreign investors, which included promoting Macedonia in many of the worlds leading newspapers and magazines, and visiting many governments, businesses and business associations throughout the world. Macedonia is in the process of harmonizing its legal and regulatory systems with international, primarily European Union, standards. Political Violence The Ohrid Framework Agreement, signed in August 2001, ended the inter-ethnic conflict of that year by granting greater legal and political rights to Macedonia's ethnic Albanian and other minority communities. Since then, significant political violence has ceased, although there have been limited outbreaks of violent clashes in connection with election campaigns. The country has shifted its focus from security and stability to economic development and integration into the EU and NATO. Criminal violence in some areas remains a concern, although the crime rate in the country overall is relatively low. Citing political concerns, an ethnic Albanian former Member of Parliament with very little popular appeal led a small group of supporters in firing on government security forces near a village in northwest Macedonia. That individual was not arrested, but efforts were underway to resolve the standoff peacefully. There was one instance of violence directed specifically at a US investor, presumably to intimidate him during a court case over ownership of a local firm. Local police were unable to find the perpetrators, and the investor left the country. There were no other instances of violence directed at foreign business persons or investors. Corruption Like its Eastern and Central European neighbors, after the fall of communism, Macedonia inherited a government system rife with corruption. A series of laws have been adopted and amended to control crimes ranging from drug abuse to money laundering, and to create a legal firewall against corrupt practices. In addition to the Law on Criminal Procedure, which criminalizes acts of bribery and the abuse of official position, other major anti-corruption laws include the Law on Money Laundering Prevention and the Law on Corruption Prevention, which provide jail terms of up to 10 years for corruption and allow confiscation of illegally-obtained property. Macedonia has signed the Organization for Economic Cooperation and Development's (OECD) Convention on Combating Bribery. Macedonia ratified the UN Convention Against Corruption in early 2007, and has ratified the UN Convention against Transnational Organized Crime. Though most of the necessary laws are in place, enforcement is weak and the public is skeptical of the government's willingness to prosecute corrupt officials within its ranks. The

public generally views the police, courts, customs agency and the healthcare sector as the most corrupt public institutions. Transparency International gave Macedonia a score of 3.3 (on a 1 to 10 scale where 10 is least corrupt) on the 2007 Corruption Perception Index, a significant improvement over Macedonias score of 2.7 in 2006. The Macedonian Government established an independent State Commission for Prevention of Corruption in 2004. Through USAID, the US Government is supporting the commissions development and implementation of a Program for Prevention and Repression of Corruption and an accompanying action plan. Bilateral Investment Agreements Macedonia has concluded an "Agreement For Promotion And Protection Of Foreign Direct Investments" with the following countries: Albania, Austria, Bosnia and Herzegovina, Bulgaria, Belarus, Belgium and Luxemburg, Germany, Arab Republic of Egypt, Iran, Italy, Serbia and Montenegro, People's Republic of China, Republic of Korea, Malaysia, Poland, Republic of Romania, Russia, Republic of China, Slovenia, Turkey, Ukraine, Hungary, Finland, France, Netherlands, Croatia, Czech Republic, Switzerland, and Sweden. Macedonia does not have a bilateral investment or double taxation treaty with the U.S., nor have negotiations on such treaties begun. OPIC and Other Investment Insurance Programs Financing and insurance for exports, investment and development projects are made possible through agencies such as the U.S. Trade and Development Agency (TDA); the U.S. Export-Import Bank (EX-IM); the Overseas Private Investment Corporation (OPIC); the European Bank for Reconstruction and Development (EBRD); the International Bank for Reconstruction and Development (World Bank); the International Finance Corporation (IFC); the Multilateral Investment Guarantee Agency (MIGA); and the Southeast Europe Equity Fund (SEEF). Most of the funding for major projects is achieved through co-financing agreements, especially in the transportation, telecommunications and energy infrastructure development fields. OPIC and MIGA are the countrys chief investment insurance providers. OPIC insurance and project financing have been available to investors in Macedonia since 1996. OPIC's three main activities are risk insurance, project finance and investment funding. MIGA provides investment guarantees against certain non-commercial risks (i.e., political risk insurance) to eligible foreign investors making qualified investments in developing member countries. MIGA covers investors against the risks of currency transfer restrictions, expropriation, breach of contract, and war or civil disturbance. Though its primary focus is investment assistance - including direct loans and capital guarantees aimed at the export of non-military items EX-IM also provides some insurance policies to protect against both political and commercial risks. TDA, SEEF, World Bank and EBRD focus more directly on financing agreements. Labor Relations between employee and employer are regulated by an individual employment contract pursuant to Section II, Articles 13-21 of the Law on Working Relations. Employment of foreign citizens is regulated by the Law on

Foreigners. The employment contract, which must be in writing and kept on the premises, should address the following provisions: description of the employee's duties, duration of the contract (finite or indefinite), effective and termination date, location of the work place, hours of work, rest and vacation periods, qualifications and training, salary and pay schedule. The law is relatively flexible with regard to working hours. Normal working hours for an employee are eight hours per day, five days per week. According to labor regulations, an employee is entitled to a minimum of 20 working days and a maximum of 26 working days paid annual leave during the course of a calendar year. Work permits are required for foreign nationals. There is, however, no limitation on the number of employed foreign nationals or the duration of their stay. There are two main associations of trade unions - The Union of Trade Unions and the Confederation of Free Trade Unions. Each association is comprised of independent branch unions from the public and private business sector. Trade unions are interest-based, autonomous labor organizations. Membership is voluntary and activities are financed by membership dues. Almost 75 percent of legally employed workers are dues-paying union members. Due to the difficult economic climate and political infighting, the unions as a rule have not exercised much leverage vis-vis employers in recent years. National collective bargaining agreements are negotiated between the labor unions, representing the employees; the Ministry of Labor and Social Welfare, representing the Government; and the economic chambers and the employers associations, representing the employers. There are two main agreements for public and private sector on the national level, and separate contracts are negotiated by the branch unions, or at the industry or company level. The primary pressures that unions face are related to high levels of unemployment and the privatization of inefficient state companies. Foreign-Trade Zones/Free Ports There are four major designated Free Trade Zones in Macedonia: Skopje 1 (Bunardzik) and Skopje 2 - an area north of Skopje; an area in the city of Shtip; and an area in the city of Tetovo. Amended legislation has been prepared for permitting and regulating such zones, and a Directorate for Technological Industrial Development Zones was established in order to conduct activities regarding the development, establishment and supervision of activities in the free economic zones. The US company Johnson Controls, an automotive components manufacturer, in 2006 invested in a manufacturing plant in the Bunardzik FTZ and began production operations in mid December 2007. The Johnson Controls factory produces automotive electronic equipment and will employ 150 workers. With planned additional investments, the company will increase its production capacities and the number of employees will grow to 500, by 2013.

EVE GOOOOOOO
I. Introduction

Throughout the world the process of consolidation in the banking industry (M&A-mergers and acquisitions) is one of the most important developments in the financial sector. The main driving force behind this trend were different structural and institutional changes that have taken place in developed countries, such as the United States, European Union and Japan. This seems to be a very obvious consequence of the process of globalization, which in turn resulted in new kind of economic pressures for increased efficiency in the financial sector. A significant structural change in the European Union was the completion of a single market program. The objective was to bring synchronization of the existing administrative regulation, legislation to increase competition. In response to the changes in regulation, European financial institutions have attempted to improve their efficiency and attract new customers by increasing their geographical reach and the range of products they offer.

1 The desire to preserve falling (interest) margins by increasing market share and to attract new customers is often fulfilled by M&A that allow financial institutions to rapidly increase their size and to improve their knowledge of new products and markets. In recent years one of the most dynamic markets for mergers and acquisitions was the one in Central and Eastern Europe (CEE). This should not come as a surprise especially having in mind the process of privatization (transformation of the state capital) and rehabilitation of the entire banking system. Just for illustration, foreign banks acquired more than 50 financial

1 Dean Amel, Colleen Barnes, Fabio Panetta & Carmelo Salleo, Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence, CEIS Tor Vergata Research Paper Series, Vol. 7, No. 20, 2003. www.crpm.org.mk 5 Center for Research and Policy Making

institutions from South East Europe (SEE)

2 in the period between 2000 and 2005. However, Macedonia is an exception. It seriously lags regarding this trend. Realizing this weakness, the Macedonian Government led by VMRO-DPMNE has decided to undertake steps aiming at full financial liberalization. Among other things a new banking legislation is proposed. This paper gives a brief overview of the Macedonian banking system. In addition, some specific developments will be discussed by making a comparative analysis. However, its main focus is on the draft version of the proposed bank legislation and its possible implications for the Macedonian economy.

2 SEE refers to following set of countries: Albania, Macedonia, Serbia, Bosnia and Herzegovina, Montenegro, Croatia, Bulgaria, and Romania. www.crpm.org.mk 6II. The Process of Consolidation During the 1980s, banking and markets for financial services in developed

countries have experienced major structural changes, including significant reduction in the number of independent entities. A simple comparison of the concentration ratio between the US and the EU 3 area as a whole 4 indicates that this trend is far from being over. Namely, this ratio is high for each country when observed independently while the concentration on panEuropean level is significantly lower despite the process of full financial integration. A similar trend can be observed in all transition economies from Central and Eastern Europe (CEE). Domestic markets are highly concentrated, meaning that the banking sector is characterized by large number of banks, few of which clearly dominate in terms of a market share. The assets of the top five banks in each country from CEE accounts between 60% and 87% of total banking sector assets. 5

One of the most important reasons for mergers and acquisitions in the financial sector is to secure unrealized scale and scope economies. 6 Some in the academic community relate the difficulties associated with cross-border mergers and acquisitions,to the differences in the corporate culture. 7 According to them the easiest M&A are usually those where the partner or the acquired entity is geographically close, when institutions operate in similar legal and regulatory framework, and possibly share the same (or similar) language and culture. The only specific benefit, from cross border consolidation, is associated with the extra gains that might arise from diversifying the macroeconomic risk related with banks portfolio of loans

3 This refers only to EU-12, without new member states.

4 Danthine, J.-P., F. Giavazzi, X. Vives, and E.-L. von Thadden, The Future of European Banking, CEPR London, 1999, Ch. 4 and 5 5 CRPM data base on banks in SEE. 6 Molyneux, P., Y. Altunbas and E. Gardner, Efficiency in European Banking, 1997, Ch 8 7 Hoisted G., Cultures Consequences: International Differences in Work Related Values, Sage Publications, Beverly Hills CA, 1980: Kotter J., Corporate Culture and Performance, Free Press, 1992 Center for Research and Policy Making

and deposits. Equally important are the improvement in performance and increased efficiency. Recent examples in Europe were the merger of UniCredito and HVB/Bank Austria Credit Anstalt (BA-CA), which resulted in cost savings 8 and presence in 16 CEE countries with significant market

share, and the acquisition of Banca Nazionale Del Lavoro by BNPParibas.

One of the most dynamic markets world-wide for M&A in the banking sector was certainly CEE. This should not come as a surprise especially having in mind the reforms of the defunct socialist economies, the process of privatization (the transformation of the state capital), and the rehabilitation of the entire banking system. CRPM estimates that there were more than 50 mergers and acquisitions only in South East Europe (SEE) in the period between 2000 and 2005. The scale of M&A was even more pronounced at the beginning of the transition period because most of the banks were state owned (directly or indirectly-through state owned enterprises). For example, approximately 20 banks were acquired only in Serbia (in the period between 2001 and 2005). Since the transformation of the state capital is over, this trend will continue in the future but definitely at a slower pace. The following figure describes the bank ownership for

several countries from SEE. At the first glance it seems that the consolidation process of the Macedonian banking system is in its initial phase. The number of banks in Macedonia is far grater when compared to the market size (see also figure 3 for complete comparison). Furthermore, there are huge differences regarding the bank ownership across CEE. Namely, when foreign portfolio investments are excluded then the foreign ownership in Macedonia is approximately around 50%, which is the lowest in CEE. 9 Just for illustration, the share of foreign ownership in 2005 was roughly 70% in Serbia 10 and Montenegro, reaching an impressive 92% and 95% in Croatia and Romania. 8 The estimated cost savings only for Poland were approximately 600 million. 9 CRPM data base on banks in SEE.

10 The foreign ownership will further increase due to the ongoing process of privatization of remained state owned banks. www.crpm.org.mk 8 Figure 1 Bank ownership (SEE, as of 31.12.2005) Albania Serbia Macedonia Croatia Romania Montenegro Bulgaria Federation BiH Republika Srpska Foreign State Domestic Not available In Macedonia, foreign owners are essentially from Slovenia, Bulgaria and Greece Not available-same five banks which are in process of liquidation and under provisional administration from Banking Agency of the Federation BiH 3 banks are still marked as state owned although the privatization process started (but not finished) during 2005 Source: Bank of Albania, National Bank of the Republic of Macedonia, National Bank of Serbia, Central Bank of Federation BiH, Central bank of Montenegro, Central Bank of Center for Research and Policy Making

Croatia, Bulgarian National Bank and National Bank of Romania It becomes obvious that the Macedonian banking system failed to attract strategic foreign investments in the banking sector. This partly can be explained by the lack of reforms and the legal framework in this segment of the economy, discouraging foreign investors and prominent foreign-owned banks. Foreign owners currently in Macedonia are essentially from Slovenia, Bulgaria and Greece (Nova Ljubljanska Banka, UniBanka, National Bank of Greece). However, their presence produced only small changes. Namely, as competition has increased only slightly, very few new products and services have been introduced on the market III. Macedonian Banking System In general, Macedonia is experiencing a trend of permanent increase in banking activities (figure 2). However, there is a big possibility for further expansion in this market segment when compared with other countries from SEE (figure 3). The following figures illustrate this point by showing the size

and developments of the market. Figure 2 Developments in Macedonian Banking Sector 0% 5% 10% 15% 20% 25% 30% 2002 2003 2004 2005 2Q 2006 ASSETS LOANS Until the end of first quarter 2006 Source: National Bank of the Republic of Macedonia Figure 3 Size of the Banking Sector (SEE; as of 31.12.2005) 0 5 10 15 20 25 30 35

40 Albania Serbia Macedonia Croatia Romania Montenegro Bulgaria Federation BiH Republika Srpska In billion EUR 0% 10% 20% 30% 40% 50% 60% % change (previous year) SIZE (assets) GROWTH (assets) The growth of asset size in Romania was additionally increased when expressed in (EUR) due to appreciation of Romanian LEU Source: Bank of Albania, National Bank of the Republic of Macedonia, National Bank of Serbia, Central Bank of Federation BiH, Central bank of Montenegro, Central Bank of Croatia, Bulgarian National Bank and National Bank of Romania

Although growth of bank credit to the enterprise sector has been recorded, banks rarely manage to meet enterprise needs in terms of maturity and collateral requirements. Shortage of funds (access to cheap financing), lack of credit skills and unavailability of good lending opportunities are among the many possible factors responsible for low level of bank credit to the private sector. 11 In addition, domestic financial institutions fail to provide the medium and long-term financing for SMEs due to: - Requirement of collateral - typically from 150% to 300% in hard asset is required as security for a loan - Lack of adequate policies and procedures on the part of financial institutions dealing with small borrowers

11 Domestic Credit/GDP is approximately 3 times lower when compared with EU-12 average; Source: EBRD. Center for Research and Policy Making

- High level of risk - Relatively high operational costs, and

- A great number of small enterprises are not officially registered rendering them ineligible for formal credit or equity. n to be better suited than ommercial banks in serving SME borrowers. 12 ng stem. 13 The following figure describes the profitability ratios.

The growth of specialized bank and non-bank institutions specifically targeting micro and SMEs has been a partial response to the lack of credit available to this sector. Various institutions and programs have evolved, such as credit unions and micro and SME lending institutions developed by donors and non-governmental organizations (NGOs). These bank and nonbank financial institutions have often prove c The Macedonian banking system in 2005 experienced a positive trend regarding the profitability (although still lagging behind when compared

with some other countries from SEE) reaching on average 1.3% and 8.1% for ROAA (return on average assets) and ROAE (return on average equity) respectively. This was mainly due to the considerable improvement in the profitability of the group of small banks. The main driving force behind this development was the increase in net income together with a better cost efficiency in their operating activities, which is certainly an important aspect for maintaining the stability and security of the entire banki sy 12 They offer a more flexible approach, adequate training of loan officers, etc. 13 More detailed information is given in: NRMB, Report on Banking System and Banking Supervision of the Republic of Macedonia in 2005, May 2006. www.crpm.org.mk 12Figure 4 Profitability of the banking sector (SEE, as of 31.12.2005) 14 0%

5% 10% 15% 20% 25% Albania Serbia Macedonia Croatia Romania Montenegro Bulgaria Federation BiH Republika Srpska ROAA ROAE The profitability ratios for Romania refers to 31.12.2004 The latest available data for Republika Srpska was 31.12.2004 Source: Bank of Albania, National Bank of the Republic of Macedonia, National Bank of Serbia, Central Bank of Federation BiH, Central bank of Montenegro, Central Bank of Croatia, Bulgarian National Bank and National Bank of Romania

14 Finally, it is important to see the developments of all indicators presented in this section during 2006. However, at this stage is not feasible due to the fact that official data will be

available at the beginning April 2007. IV. The New Banking Regulation While the number of banks in the region is experiencing a continuous downward trend the process of consolidation of the Macedonian banking system is basically at an initial stage. Following regional trends it was reasonable to expect an entry of prominent foreign commercial banks on the Macedonian market well before 2006. However, what is somehow unique for Macedonia is that the banking sector remained closed for renowned foreign financial institutions. In certain cases this is not due to a lack of foreign interest, which is apparently present. 15 However, whether certain financial institution will be acquired or not mainly depends on the willingness of the current ownership structure to sell their shares and step down from their privileged positions, which is always very difficult. It is obvious that banks in Macedonia make extra profit. This is mainly due to

the low-inflation environment in which they operate and the (unreasonably) high interest margins charged for their products (regarding the risk and cost of capital). There are serious negative implications on the economy and its growth potential. Consequently, the most important factor concerning the current state of affairs in the Macedonian banking system is the lack of serious foreign competition from strong financial institutions that have practically unlimited access to: - Cheap financing - Technical support, and - Superior management

15 Some examles are: Postenska banka, Moznosti, Rado Banka, Makedonska Banka, Komercijalna Banka, etc. Making Center for Research and Policy

The present Macedonian Government is aware of the problem and is committed to resolve this issue. A new bank regulation 16

has been prepared and is expected to become a law in the next few months. This draft policy measure is a very important step to increase the existing confidence in the local banking sector. It is set to improve the legal and regulatory environment, and the field of banking supervision. The new banking legislation sets out the possibility for the foreign financial institutions to open branches on the Macedonian market. Namely, banks from the EU will be able to carry out all activities for which they are licensed in the country of their origin. 17 However, certain conditions have to be fulfilled, such as: - A minimum capital requirement in the amount of 5 million - An obligation for preparing financial statements and periodical reports for the National Bank of Macedonia for the purpose of monitoring bank liquidity and its operating activities - Preparing and publishing financial reports on annual basis - Adopting minimum standards for prevention of money laundering.

In addition, all deposits collected from the Macedonian public will be included in a compulsory bank insurance system according to the existing rules and regulation from the country of origin. 18 This might create favorable conditions for attracting larger amount of deposits simply because better protection system against the possible losses might be offered by the branches in comparison with the Macedonian banks. The following table describes bank insurance systems for several European countries.

16 Available at the web page of the Ministry of Finance: (http://www.finance.gov.mk/zakoni/predlozi/predlog_zakon_za_ba nkite.pdf) 17 Banks from third countries can also open branches under similar rules and conditions that are applied for institutions originating from EU, conditional on reciprocity agreement. 18

This refers only to branches opened by financial institutions from EU. Branches from third countries have to act in accordance with the rules and regulations applied for Macedonian banks. www.crpm.org.mk 15Table 1 Compulsory bank insurance system Country Deposit coverage Belgium Fully up to 11,820.00 France Fully up to 57,310.00 Germany Up to 30% of bank equity Italy Fully up to 130,290.00 and 75% of next 521,170.00 The Netherlands Fully up to 18,600.00 UK 75% of the first 28,570.00 Switzerland None Macedonia Fully up to 10,000.00, or 90% up to 20,000.00 Included only for illustration. Source: Burda, M. and Wyplosz, Ch. Macroeconomics: a European text, second edition, Oxford University Press, 1997 It should be pointed out that according to the current legal regulation full

liberalization in this market segment was planned for 1 st of January 2008. The intention of the current Macedonian Government and the new legislation is to accelerate (or shorten) this process by removing all administrative barriers and simplifying the procedures for prominent financial institutions to enter the Macedonian market. This should not come as a surprise especially having in mind the situation in our banking system and its weaknesses. The final outcome of this process should result with an increased competition, new banking products and finally, significant reduction of interest rates. In addition, the new banking legislation also prevents from possible entry of undesirable (suspicious) capital that might put the entire Macedonian banking system at risk. According to the new (proposed) legislation, Macedonian banks will operate in compliance with the Basle Committee Core Principles and EU directives concerning the setting of minimum levels of capital adequacy.

19 Further improvements can also be noticed in the mandatory adaptation of

19 They are designed to protect the banking system from individual bank risk by requiring owners capital to be constant fraction of total risky assets. Center for Research and Policy Making International Accounting Standards (IAS) by all banks. Additionally, the new banking law will strengthen the central bank enforcement and regulatory power and responsibility of the banks management bodies. However, the new legislation is not perfect. There are certain technical issues that can be improved. The proposed concentration of power into a single person the Governor of the National Bank can be considered as one of the biggest potential problems of the draft legislation. On the one hand, the need for strengthening the banking sector in Macedonia is primary rational for this proposed measure. Indeed, strengthening of the central

bank enforcement and regulatory power is essential. However, delegating power to a single person without establishing proper instruments for control might be counterproductive. This might lead to the creation of favorable conditions for corruption and misuse of power in the future. A serious argument against this policy measure is the negative Macedonian experience with the involvement of senior public officials (such as the Governor or ViceGovernor) from the National Bank in alleged criminal activities. 20 The lawmakers should consider if it is more reasonable to delegate such power to another body (for example the Council of National Bank of the Republic of Macedonia) rather than to the Governor itself. An additional problematic aspect of the draft law is the criteria for deciding who can be a shareholder or person having special rights and responsibilities within the bank. Namely, according to the Article 11, Paragraph 3, Item 4 and 6, a person cannot become bank shareholder if he

does not possess personal integrity and if he does not ensure bank stability. Similarly, according to Article 81, Paragraph 2, Item 5, a person cannot have special rights and responsibilities within the bank on the same grounds.

20 This topic received huge media coverage in Macedonia. Following list of articles (retrieved from the World Wide Web) are discussing this issue: http://www.a1.com.mk/vesti/default.asp?VestID=28331 http://www.vest.com.mk/default.asp? id=72609&idg=4&idb=1066&rubrika=Crna+Hronika http://www.utrinskivesnik.com.mk/? ItemID=D24B56F97CAF7E4CB55197EF5781764A http://www.dnevnik.com.mk/? itemID=43B1B417A16BFE4EAA865A31EE21CF07&arc=1 www.crpm.org.mk 17 Center for Research and Policy Making

The main problem arises due to the definition presented in Article 2, Item 29. Namely, a person having integrity is described as: honest, competent, and industrious (hard working), that possess skills that ensure banks stability

and reputation. However, the decision about who fulfils such personal characteristics is left to the discretion of the Governor and thus prone to subjectivity. In addition it is difficult to measure personal characteristics and especially the trait of being industrious. www.crpm.org.mk 18V. Concluding Remarks At this moment, the failure of the Macedonian financial system to respond to the demand for finance by the local private sector appears to be a significant problem for economic growth. With the capital market being underdeveloped, the burden of intermediation of savings for financing private enterprise sector development is fully on the shoulders of the banking system, which still largely is in the need of significant reforms. Furthermore, the resulting degree of financial intermediation is much lower when compared with that in Western economies. The Macedonian Government shows an increased awareness and commitment to resolve this issue through the new (proposed) bank

regulation, which is expected to become enforceable in the next few months. It is a very important step forward concerning the liberalization of this market segment (by removing all administrative barriers and simplifying the entry procedures for prominent financial institutions on Macedonian market), the improvement in the legal and regulatory environment, and banking supervision. Reforms in all these areas can be considered as crucial to increase the efficiency and existing confidence in the local banking sector. As the new regulation is still under discussion decisive conclusions can be given only when the final version of the Law will be adopted. Despite some shortcomings the proposed reforms can be considered as significant step forward in improving the Macedonian banking system.

USTE EDEN FYR Macedonia 2010 Article IV Consultation Concluding Statement Skopje November 17, 2010

This statement presents the findings and main recommendations of the IMFs 2010 Article IV surveillance mission. Article IV surveillance missions are conducted with all IMF member countries on a regular basis. The mission is grateful to the authorities for their gracious hospitality and cooperation. Overview 1. Economic prospects in Macedonia have improved over the past year. Although the recovery of growth has been slower than expected, the improvement in external conditions and sound balance sheets in the banking system provide a solid platform for a more robust upturn in 2011. External risks remain high, in light of the unusual levels of uncertainty regarding the economic and financial outlook in Europe. Against this background, the authorities macroeconomic policies should strike an appropriate balance between supporting economic recovery and guarding against risks. Macroeconomic and financial outlook 2. The mission expects output to grow somewhat more than 1 percent in 2010, as activity is picking up in the second half of the year. We expect consumption to strengthen in the second half, adding to the rebound in exports that has been taking place. This outlook is consistent with the upturn that is visible in indicators such as retail sales and consumer credit. Inflation is expected to be around 1.5 percent. The momentum in the second half of the year should carry over into next year, leading to growth in the 33 percent range in 2011. Factors supporting this outlook include the recovery in the economies of Macedonias trading partners, lower interest rates, growing bank deposits, and ample liquidity in the banking system. Inflation in 2011 is expected to rise to around 2.5 percent, due in part to higher food and fuel prices. 3. The mission expects the current account deficit to narrow to 3-4 percent of GDP in 2010, due both to a smaller trade deficit and to strong private transfers. This is a rapid adjustment from the large deficit of two year ago and has supported a stabilization of foreign exchange reserves. For 2011 and over the medium term, the mission expects continued growth in exports, which

should be supported by strong metals prices and higher capacity resulting from past foreign direct investment. Import growth is also expected pick up as the economy recovers. The mission expects the current account deficit to widen modestly next year to 4-5 percent of GDP and to stabilize over the medium term at levels that can be financed largely by foreign direct investment. 4. The banking sector appears to be in sound shape. Capital ratios have remained above 16 percent, well over the regulatory minimum, with tier 1 capital at over 13 percent. Non-performing loans have risen during the past two years but have been largely provisioned. Loans are funded through domestic deposits, which are a relatively stable source of financing, and reliance on foreign financing is low. Finally, bank liquidity is strong, which together with ample capital and growing deposits, puts the banking system in a good position to increase lending to the economy. Risks 5. The main risks come from continued uncertainties in the economies of Macedonias trading partners and in international financial markets. Financial conditions remain unsettled in several Eurozone countries, where negative events could spill over to Macedonia in the form of lower demand for Macedonian exports and reduced access to external financing. Such a downside scenario could undermine the expected resumption of healthy growth and result in new pressures on external and fiscal financing. On the upside, faster recovery in Eurozone and in other neighboring countries could give a stronger boost to exports and support a more vigorous rebound in growth. Progress towards EU accession would improve prospects for foreign investment and growth. Fiscal policy 6. The mission views the governments deficit targets of 2.5 percent of GDP in 2010 and 2011 as appropriate in light of current conditions. This fiscal stance will help to support output and employment and minimize the need for spending cuts, while maintaining debt ratios at moderate levels. Macedonia has benefited from a legacy of sound public finances in recent years, which has provided room for larger deficits during periods of

economic weakness. It will be important to reduce deficits over the medium term to preserve debt sustainability and keep space to respond to future economic cycles. Moreover, as public debt transitions from official lending to more expensive private financing over the medium term, lower deficits will be needed to keep debt ratios stable at moderate levels. 7. The government faces two challenges in the fiscal area in 2011 and over the medium term. First, the 2011 budget relies on private external borrowing to cover the fiscal deficit. It would be prudent to access external markets early in the year, provided market conditions are favorable, to prevent the emergence of domestic financing pressures and to avoid the risk that external market conditions worsen later in the year. Over the medium term, as healthy growth resumes and risks abate, the government should work to develop local public debt markets, including at longer maturities, to reduce exposure to volatility of external financing conditions. Second, the planned reductions in social contributions in 2012 and 2013 are beneficial from the viewpoint of fostering formal sector employment and attracting investment, but they will place pressures on the budget. It will be important to continue to contain government consumption and transfers to prevent higher deficits, while protecting investment spending that is needed to raise growth potential. Monetary Policy and Financial Stability 8. The National Bank of the Republic of Macedonia (NBRM) has reduced its policy rates substantially over the past year, to 4.5 percent at present. The mission views this as an appropriate response to the easing of external financing pressures in a context of weak growth and subdued inflation. As lower interest rates gradually filter through to lower bank lending rates, this should support the economic recovery. Looking forward, monetary policy should be guided foremost by the need for consistency with the exchange rate peg to the euro, and in particular by the need to maintain an adequate level of official international reserves. The scope for further easing is limited. In this regard, one factor is that the spread between the NBRM and European Central Bank policy rates has narrowed. If this spread

were reduced too much, this could lead to a shift towards foreign assets by Macedonian residents and create pressures on international reserves of the NBRM. 9. The quality of banking regulation and supervision, conducted by the independent NBRM, has contributed to the stability of the banking sector. Careful attention to capital ratios, conservative practices in setting reserve and liquidity requirements, and close monitoring of bank balance sheets and lending practices have been important in this regard. The mission welcomes the submission to parliament of the new NBRM law, which would bring legislation fully in line with EU and Eurozone standards. The mission also supports the authorities actions to strengthen crisis response mechanisms by making the Financial Stability Committee operational. NBRM initiatives in other areas such as mechanisms for providing emergency lending assistance in the event of liquidity shortfalls, and measures to bolster the NBRMs authority to take necessary actions in the event of financial stress, are also welcome.