The Impact of the Economic Crisis on EU Integration

The current economic crisis is a real-life stress test. Like elsewhere, the strengths and weaknesses of the economy, public institutions, and the general ability to respond—timely and adequately—to the challenges of this crisis are being exposed, evident even to the casual observer. Crises are always defining moments. The decisions, which the Government will take in the weeks to come, define whether Montenegro can come out of the crisis strengthened—or whether it will be weakened, lingering towards a prolonged period of economic anemia, comparable to that seen before the economic boom.

In a strange sort of way, the overall context, within which decisions have to be taken, is as beneficial as possible under current circumstances. First, elections have resulted in a clear outcome, having given the Government a clear mandate for the reforms required to make a “European” Montenegro a reality. Second, the European Union has responded positively to Montenegro’s recent membership application, permitting the country to present its case to Brussels. And finally, the crisis has exposed the areas of greatest weaknesses, defining immediate political and—especially—economic priorities, thus permitting the Government to convince its skeptics of its determination, seriousness, and competence needed to address the plethora of politico-economic challenges.



In December 2008, the Government took the EU’s promise of applying the regatta principle seriously, made its case, and decided—notwithstanding voices of caution—that it was the right time to submit its application to the EU. It might have been a gamble, but it paid off—largely because Montenegro was prepared and able to back up its case with a legacy of reforms. Having qualified, the bars are being raised now for the real competition.



Awaiting Brussels’ lengthy questionnaire, the responses to which will form the basis for the ultimate decision on Montenegro’s preparedness for candidate status, the time has come to internalize fully the EU’s principal promise, the one the EU has extended to all the countries of the Western Balkans: implementing policies in full compliance with the Copenhagen criteria will open the doors to EU membership. There are three groups of criteria, viz., (i) political criteria, relating to the stability of institutions guaranteeing democracy, the rule of law, human rights, and respect for and protection of minorities; (ii) legal criteria, relating to the acceptance of the acquis communautaire, demonstrating the country’s ability to take on the obligations of membership, including adherence to the aims of political, economic, and monetary union; and (iii) economic criteria, requiring the existence of a functioning market economy and the capacity to cope with competitive pressure and market forces within the EU.



Maybe not surprisingly, I will—in what follows—largely focus on the last set of criteria. And here, I believe, it becomes evident how the effective crisis response is entirely congruent with—in fact, largely defines—the EU integration agenda. I will mention only two examples.



First, the financial sector. We are all aware of the fact that the growth prospects of Montenegro’s economy—certainly this year—is constrained by the lack of credit from the banking sector. Following unparalleled private-sector credit growth rates during the boom years, financed by rapid increases in deposits and—at least in 2007—external credits from the parent banks, the financial crisis led to gradual (but consistent) withdrawals of deposits from the banks. Foreign parent banks became unable and unwilling to lend to the Montenegrin banking sector, certainly not in amounts comparable to the boom years up until the third quarter of 2008.



Considerably lower inflows of FDI, paired with tighter liquidity in the banking sector, both domestically and internationally, led to the dramatic deceleration of economic growth, which, in turn, affected detrimentally the ratios of non-performing loans—in some banks more so than in others, given their respective credit policies during the boom years. In hindsight, it is clear that the central bank measures, introduced in late 2007, as well as subsequent steps taken to strengthen banking supervision were correct, but they came late and were not strong enough—largely reflecting the legal constraints placed upon central bank conduct, as currently contained in the banking law.



A careful analysis of institutional features that have permitting recent developments in the financial sector to unfold should thus culminate in a debate on improved banking and central banking laws, fully in line with international best practice and European standards. In so doing, Montenegro would draw the appropriate lessons from the current crisis, while taking another important step in shadowing the obligations of a member of the euro zone. This will prove crucial once actual negotiations on membership commence.



At the same time, such a step makes economic sense. If one looks at the monetary history of countries in Europe and elsewhere, it will become evident that confidence in the financial sector can be strengthened by a policy commitment—on paper and in practice—to strong and independent central banks. It is thus no surprise to see that long-term economic performance of countries with enshrined central bank independence tends to exceed those, where central bankers need to conform their policies to the priorities of the government.



Second, the capacity to cope with competitive pressures. During the last few years, the Government has largely relied on foreign investments as a means to foster economic growth. This has proven a very successful policy, with growth rates during the immediate post-independence period exceeding those of countries elsewhere in Europe. Clearly, Montenegro’s ability to attract foreign investors would continue to help the Government in realizing its socio-economic objectives—but in an environment of a global liquidity squeeze, comparable inflows of foreign direct investment cannot be taken for granted.



Thus, in terms of crisis response, policymakers will have few options but to concentrate on those policy measures that are most effective in fostering innovation and the increase of overall productivity, both in terms of invested capital and employed labor. Government has several powerful instruments—public institutions, laws, regulations, and mechanisms ensuring their rules-based application. Today—even more so than in the years before—it is paramount that attention is being paid to the quality aspects of public expenditure, the careful definition of objectives and priorities, the strict adherence to highest standards during implementation, and the ex post assessment of whether, or to which degree, pre-specified goals were realized with the policies implemented.



This is hard work in areas where benefits can be had only indirectly and often with a considerable delay. High-quality public goods and a good and well-maintained public infrastructure enable viable enterprises operating in Montenegro—whether domestic or foreign-owned, small and large, connected or not—to remain successful, even in times as difficult as today.



This has budgetary implications, not least in relation to the emphasis placed on developing a consistent, medium-term expenditure framework, ensuring financing security for the highest-impact public infrastructure investments over the horizon of several fiscal years. This requires the definition of mechanisms within Government that allow for a prioritization of expenditures in relation to their socio-economic impact. At the same time, these are the types of reforms that, among several international organizations, the EU assesses periodically in its annual Progress Reports.



Again, there is a full congruency of effective crisis response and European integration objectives. Genuine efforts taken to address, in a serious manner, the various challenges caused by the current economic crisis, candidly described by the media, will earn respect and facilitate the decision by the current EU member countries to invite Montenegro to join them. No doubt, many decisions will be very difficult, and they will not be popular, certainly not in the short term. International institutions, like the one I represent, are willing to provide support, if requested by Government, in seeking most effective ways in addressing the most critical challenges.



And here, Montenegro can and should take full advantage of one specific feature of its economy, its relatively small size. Results become apparent and a corresponding reputation can be built more quickly. Thus—irrespective of the developments within the EU, or the time required to sort out the current institutional impasse—the clear focus on reforms aimed at strengthening public institutions, increasing the quality of the public goods, and ensuring the transparent and uniform application and judicial verification of rules and regulations promises considerable benefits, both in economic terms and relative to Montenegro’s EU integration agenda.



And with the ensuing improvement in the domestic business climate and, concomitantly, a more tangible EU integration perspective, investors’ confidence in Montenegro as a destination for economic activities will increase. Taking the crisis, which occurred for reasons entirely outside of Montenegro’s control, as an opportunity to focus on what is crucial, it is possible to set off a virtuous cycle towards a more successful and more prosperous Montenegro, with firms strong enough to compete in regional and European markets.



What are the alternatives?