Challenges in the Sectors of Enterprise and Industrial Policy

5th meeting, Podgorica, 2 December 2014

Montenegro's accession to the EU:

challenges in the sectors of enterprise and industrial policy

Drawn up by Mr Vincent Farrugia, member of the EESC and of the EU-Montenegro JCC

1. Introduction and objectives

At the Intergovernmental conference of 18 December2013, Montenegro opened negotiations on Chapter 20 of the accession negotiations, - Enterprise and Industrial Policy.

The acquiscovered by the chapter on Enterprise and Industrial Policy consists of policy principles and instruments, which are mainly reflected in communications, recommendations and Council conclusions and are mostly implemented at EU level through the Competitiveness and Innovation Programme. They are also the subject of an EU-wide consultation on structured exchanges of good practice. Enterprise and Industrial policy is strongly driven by the Europe 2020 Strategy.

In these negotiations, the EU seeks to promote the formulation of competitiveness-enhancing enterprise policies and industrial strategies based on established general policy principles in line with Article 173 TFEU and aims to:

• speed up structural adjustments
• encourage an environment favourable to business creation, and to both domestic and inward foreign investments
• promote small and medium-sized enterprises (SME), as well as entrepreneurship and innovation.

More specifically, the EU ensures that enterprise policy emphasises its policy on SMEs, as characterised by the policy recommendations and joint policy review mechanisms contained in the Small Business Act (SBA). This is the main reason for the EU’s insistence on establishing general policy principles.

Enterprise and Industrial policy instruments incorporate the major planned actions under the EUCompetitiveness and Innovation Programme(CIP), while its specific programme, the Entrepreneurship and Innovation Programme (EIP), provides financial support to enterprises and policymakers and is focussed on actions that promote access to finance,business services such as the Enterprise Europe Network (EEN), European and national innovation policy and policies in support of SMEs.

Another important facet of this chapter is Enterprise and Industrial Sectoral Policies. The European Economic and Social Committee is particularly keen to ensure that in its negotiations,the EU promotes a more targeted analysis of the competitiveness of specific sectors and the launch of sector-specific initiatives such as high-level groups, policy forums, studies and expert panels as well as networking initiatives.

Progress in these areas can only be achieved through adequate administrative capacity at national, regional and local level, including efficient consultation processes and cooperation mechanisms.

2. EU Macroeconomic Assessment

On January 2014, Montenegro submitted its 2014Pre-Accession Programme covering the period 2014-2016. The EU Council considered the programme to be broadly optimistic with regards to the macroeconomic scenario underpinning the programme's budgetary projections. The programme aims to achieve real growth of 3.8% by 2016, relying on a sharp increase in investment to replace net exports as the main engine of growth, while the structurally high current account deficit would decrease. The Commission, however, forecasts a lower growth path,in addition to a deterioration of the current account deficit, based on a higher dependency on imported investments.

Furthermore, neither the 2014 Budget Law nor the medium-term Pre-Accession Economic Programmeincludes the fiscal impact of the debt-financed Bar-Boljare highway or the Smokovac-Matesevo section, the construction of which was planned for 2014.These are important considerationsfor the evolution and effective implementation of enterprise and industrial policies, as macroeconomic programming continues to have a considerable impact on the performance of the enterprise and industrial sector. Demand for new businesses and for the growth of particular business sectors are greatly affected by overall fiscal policies and the major and pressing fiscal challenge of decreasing public debt overshadows the evolving industrial strategy.

This backdrop is crucial when assessing the industrial policy document that Montenegro will present by the end of January 2015. It is worth pointing out here that investment and industrial policy is also affected by monetary and exchange rate policy, but due to the Euroisation of Montenegro’s currency, fiscal policy remains the main policy instrument available to smooth out the economic cycle. This raises the concerns of enterprise and industry in their evaluation of fiscal policy and its impact on the climate for investment and is therefore essential to the implementation of the planned industrial strategy.

The new Budget and Fiscal Responsibility Law is another essential stepping stone for building confidence and macroeconomic stability, which is important for the implementation of an effective industrial strategy. The law sets fiscal rules such as upper limits for budget deficit and public debt - 3% and 60% of GDP respectively. The EU Council attaches great importance to this law and insists that the Montenegrin authorities ensure its effective implementation while exercising caution when issuing state guarantees. This caution is noted particularly by enterprise and industry.

The EU Council also emphasises the importance of structural reform. This is also essential for investment, since the private enterprise and industrial sector cannot expand within the framework of a planned industrial strategy if non-discretionary spending on pensions and public sector wages continues to predominate. Such expenditure was frozen for 2013 and 2014 without due consideration being given to the impact on expenditure sustaining private consumption, which is so essential for keeping SMEs afloat in retail and services. Additional reforms, however, would need to be considered to achieve long-term sustainability, such as the planned alignment of public administration salaries and steps towards the reorganisation of the public sector and pensions. These measures form an important background when assessing the impetus of the new industrial strategy.

The Council also observed that Montenegro faces a number of challenges relating to economic competitiveness. The macroeconomic policy tools to steer the economy on a path of sustained convergence are severely constrained by unilateral Euroisation. At the current juncture, the central bank’s lack of a policy interest rate and the significant limitations on its role as lender of last resort reduce its ability to influence bank lending and thereby to support the real economy and economic growth. The weak pace of lending by banks and a high burden of non-performing loans on bank balance sheets remain the main short-term challenges hampering the growth of investment and the promotion of new investment in business.

Progress has been achieved in spite of the limitations caused by the recession and the absence of monetary policy instruments, but there is scope for further improvement to the business climate. The discussion on Chapter 20 aims to identify current shortcomings and promote the EU policy framework, whichrepresents a substantial step forward in enabling investors to benefit from increased predictability and simplification in the regulatory environment, and from greater transparency and a reduction of red tape and costs with regard to construction permits and fees, especially at the local level. For the enterprise strategy to flourish, greater efforts also need to be made to improve the judicial system and in particular contract enforcement.

The current macroeconomic assessment also led the EU Council to conclude that labour market imbalances are reflected in persistently high youth and long-term unemployment. Moreover, the major disparity between education outcomes and labour market demand is causing higher structural unemployment. The delay in the reform of the education system, the national collective agreement, which applies to both private and public sectors and is inherentlyinflexibility regarding the wage- setting process at company level, inadequate efforts to tackle informal employment and underutilised labour are all important determinant factors in deciding on the appropriate enterprise and industrial strategy.

3. Impact of EU Council Conclusions

The discussion on this chapter will therefore be greatly influenced by the results of the EU Council’s advice to Montenegro, especially as it concerns the following:

-reducing public debt, especially to limit the impact of financing the motorway;

-implementing the law on Budget and Fiscal Responsibility effectively;

-improving the transparency of public finances by adopting a strategy for the implementation of the European System of Accounts (ESA2010) and by issuing fiscal notifications;

-preparing an initial review of the old-age pension indexation system, restructuring the public sector and reforming public sector salaries, in order to remove disparities across public bodies. Salary structures in the public sector greatly influence the flow and availability of skilled personnel to the private sector and are essential to industrial strategy implementation;

-further improving predictability and simplifying the regulatory business environment,notably by means of the so-called “regulatory guillotine”, and reducing the costs of municipal fees for construction permits without endangering the sustainability of local government finances;

-pursuing educational reform, with a view to better aligning education and skills with labour market needs and to strengthening cooperation between education and business;

-bringinggreater flexibility to the labour market through distinct collective agreements for different public and private sectors;

-implementing the planned voluntary financial restructuring programme to address the high burden of non-performing loans on bank sheets from both a stock and flow perspective. A stronger banking structure is vital for business to flourish and to have a successful enterprise policy and industrial strategy;

-finding a permanent solution for the KAP aluminium company, as the size and influence of this single industrial compound has too great an impact on the rest of industry.

4.Issues raised during the screening exercise

The institution that shapes and coordinates enterprise policy in Montenegro is the Council for Regulatory Reform and Improvement of the Business Environment. This body is headed by the prime minister, who ensures the cooperation of all government bodies and the private sector. In cooperation with line ministries, the Council, together with the Ministry of Finance,coordinates activities in all areas of the economic system in order to create a more favourable business environment. More specifically, it proposes regulatory reforms by analysing regulations concerning the elimination of business barriers in order to simplify procedures. The private sector organisations directly involved are the Chamber of Commerce, the Employers’ Federation, the Montenegro Business Alliance and the Chamber of Skilled Crafts.

Montenegro has adopted 18 strategy papers which set out enterprise and industrial policy in broad terms. The implementation and monitoring of individual strategies and the achievement of set targets are the responsibility of the various line ministries. These strategies cover areas such as competitiveness, fiscal policy, sustainable development, regional development, foreign direct investment, export support, and SMEs. Montenegro is currently concluding its draft of a new strategy on manufacturing industry and is planning the adoption of a comprehensive industrial policy document that would embrace the main elements of the 2020 Strategy. Through projects financed by the Instrument for Pre-Accession Assistance, the European Commission and the Organisation for Economic Cooperation and Development (OECD), Montenegro is being directly assisted in these projects.

Through these initiatives Montenegro aims to achieve the following:

-increased accumulation of capital

-restructuring towards more efficient sectors (energy, sustainable development activities agriculture and food processing)

-diversification of the sectoral structure of the economy

-improved infrastructure

-greater privatisation

-a better framework for entrepreneurship

-improved competition in the markets

-an enterprise policy that is geared towards SMEs, which contribute 60% of GDP and employ 60% of the total labour force. The rules for classifying companies as SMEs are laid down in the law on accounting and auditing.

Of the 18 strategies adopted concerning enterprise and industrial policy, 3 deal with SMEs:

1)the Strategy for Competitiveness Support to Micro Enterprises

2)the Strategy for Small and Medium Enterprise Development

3)the Strategy for Lifelong Entrepreneurial Learning.

Three public sector/private sector participative bodies supervise the implementation of these strategies, under the responsibility of the Ministry of Economy.Montenegro has screened primary and secondary legislation, and all new legislation is now subject to regulatory impact assessment (RIA). Montenegro also appliesthe “regulatory guillotine” process to simplify legislation. The Ministry of Finance has overall responsibility.

Under the Entrepreneurship and Innovation Programme (EIP), which is part of the EU Competitiveness and Innovation Framework Programme, Montenegro has established the Enterprise Europe Network (EEN), a partnership between the Ministry of Economy, the Chamber of Commerce, the Faculty of Mechanical Engineering and the Start-up Centre of Bar.

The main national instrument supporting enterprise and industry is the Investment and Development Fund of Montenegro, which provides loans at low interest rates to companies in selected activities. Most of the enterprises supported are from the industrial sector.

The Investment and Development Fund, in cooperation with commercial banks, also establishes guarantee schemes to improve access to financing for the real economy.

The EIP also finances projects geared towards eco-innovation and entrepreneurship for women.

Funds for new entrepreneurs and subsidies for new job creation are provided by the Montenegro Employment Agency.

A cluster and business zone programme aimed at providing coordination of regional development and sectoral expertise support, such as clusters in agriculture, for example, is also in place.

The issue of liquidity problems for businesses is being tackled through the legislation on late payment, representing Montenegro's action on Directive 2011/7/EU. The legislative measures establish the following principles: 1) the default interest rate; 2) the naming of companies in financial difficulties; 3) deadlines for setting liabilities.

On sectoral policies, the screening exercise has established the following:

• A comprehensive sectoral strategy applying only to tourism. The strategy is closely interlinked with strategies for sustainable development and human resource development in the tourism sector.
• No comprehensive strategy applies to the food and processing industry.
• Comprehensive strategy and policy guidelines policy document is available for a number of important industrial sectors: metal, wood, construction, aviation and maritime.

5. Degree of alignment and recommendations

Overall, the level of alignment with the acquis is satisfactory. The country has produced a number of strategies that are addressing the competitiveness of its economy. Responsibility for the design and implementation of the policy is shared among various institutions.

-Montenegro, however, needs to improve the implementation and coordination of these policy strategies and institutions.

-Montenegro needs to further improve its capacity to collect business statistics, without which no effective analysis can be made to identify the measuresneeded to improve the business environment and to implement focussed policy making. Some business-related indicators, especially at the sectoral level, are not available, thus denying policy-making the analytical capacityit needs. Future policy-making should increasingly be based on statistical evidence, in line with the obligationsset out in Chapter 18 of the acquis – statistics.

-Montenegro also needs to greatly improve the existing mechanism for cooperation with stakeholders.

-Regarding sectoral policies, Montenegro mustgive greater consideration to the manufacturing industries, as these account for 5% of GDP and need direct support under a comprehensive strategy geared towardsa better spread and utilisation of the economic growth potential of this sector.

-Montenegro has also produced a substantial number of enterprise and industrial development policy documents incorporating EU principles in these matters. The mechanisms for the regular review and evaluation of these strategies, however, are not yet in place.

-Montenegro needs to develop its analytical and policy governance capacities to ensure closer co-operation with Member States, as prescribed in Article 173 TFEU, and to monitor the success and competitiveness of industrial policies within the context of the Europe 2020 framework.

-On SME policies, according to the EU and the OECD SME policy index on performance within the Small Business Act framework, Montenegro is rated as good but uneven in performance. Company registration, the start-up process and regulatory reform are evaluated as good. Implementation of SME policy and support for innovation and provision of public services to SMEs, including entrepreneurial learning programmes,receive a negative assessment, however.

-Montenegro needs to work much harder to bring the private sector on board, with businesses complaining that although they are regularly invited to comment on new legislative and policy proposals, their suggestions tend not to be taken into account.

-Montenegro needs to take further action and be more effective on the following issues: access to finance, business licensing and permits, competition from the informal economic sector and fighting corruption as it affects enterprise.

-Montenegro needs to strive harder to avoid the threat of unpredictable public sector action, as this also damages business.

-Montenegro also needs to address the issue of high energy costsfor businesses more effectively.

6. Current planned action to implement recommendations

6.1 Economic performance

The Montenegrin economy returned to robust growth in 2013. The higher output in 2012 contracted (-2.5%) due to sluggish credit activity, adverse weather conditions that limited energy production, the bankruptcy of the steel mill company, and falling production at the loss-making aluminium plant, KAP. In 2013, the economy grew again by 3.5%, with GDP returningin constant prices to the pre-crisis level (2008). Inflation fell to 2.2% from the high of 4.4% in 2012, reflecting the dissipating effect of food and oil prices. Growth is expected to rise to around 3.2% over the medium term, supported by foreign direct investment (FDI) in tourism and energy, as well as public investment.

External vulnerabilities decreased slightly in 2013, driven by the falling trade deficit and deleveraging by corporates. The current account deficit (CAD) on a rolling basis decreasedby 16% to EUR490million or to 14.7% of GDP. Importantly for business growth, this was underpinned by service income growth of over 5% on an annual basis and a rise in workers' remittances of almost 4%. After a long period of decline, goods exports also increased by almost 3%, led by electricity, while metal exports contracted.