Richard Cowper

Balkan commentator Richard Cowper travels to Montenegro to take a look at how its economy is faring in its first full year since it became the world's newest independent nation. 10th March 2008.

Montenegro's economy gets off to a rock-and-roll start, but corruption problems remain

By Richard Cowper in Podgorica*

Montenegro, the tiny jewel on the Adriatic coast which boasted a Rolling Stones concert last year and looks set to get Madonna in 2008, has got off to a rock-and-roll economic start in its first full year since becoming the world’s newest nation in May 2006.

Record tourist numbers of nearly 1.2m, soaring foreign investment inflows and rising export sales from KAP, the country’s newly privatised aluminium plant, produced an official growth rate of 7 per cent in 2007 and many economists expect this to continue in 2008.

Real estate sales along the country’s coast were nothing short of a phenomenon in 2007. “It seems that every Englishman and Russian with a million euros in the bank who has been to Montenegro has fallen *in love with it and wants to come back in a yacht or buy one of the grand stone villas or farmhouses overlooking the mountains and Kotor bay,” says one consultant at a leading foreign property company in the country.

Under its wily and determined leader Milo Djukanovic, now in his fifth stint as prime-minister of this nation of around 650,000 inhabitants, Montenegro has opted to look firmly west, while pursuing close ties with its larger and more powerful neighbour, Serbia.

Last year it joined the World Bank, which has placed an influential representative in the capital Podgorica and became a member of the International Monetary Fund. Having signed a stabilisation and association agreement with the European Union in October 2007 it hopes eventually to join the European Union and more controversially Nato, though in the case of the former this could well take up to a decade to achieve. It is not yet a formal EU candidate country. It is also in the process of acceding to the World Trade Organisation (WTO) and has become a party to the Central European Free Trade Agreement (CEFTA).

Its decision to adopt laws and an economic approach which should eventually place it alongside the free-market nations of western Europe, have combined with its stunning mountainous scenery and dramatic coastline to sharply boost foreign investment and attract a growing influx of foreign visitors.

In a country where agriculture and smuggling only recently played major roles, tourism and real estate have become the twin pillars of the economy. In 2007 gross domestic income per capita grew to Euros 3,700 - the same level or slightly above the values for most other Western Balkan countries, but still considerably lower than most new EU member states, with the exception of Bulgaria and Romania.

Unemployment has fallen sharply since independence, with official figures showing a jobless rate of just under 12% last year, down from 33% in 2000.

“Look you could not ask more of an ex-communist nation in its first 18months as a nation and one that less than a decade ago was in the middle of a war zone and had the might of United Nations sanctions directed against it at that,” says a senior foreign economist in Podgorica, the fast-growing, inland capital.

According to the Ministry of Tourism revenues from tourism generated Euros 480m in calendar 2007, up 39 per cent compared with the same period in 2006. Just over 1m foreign tourists visited the country in 2007 – a post-Yugoslavia record with 385,769 Serbians (37% of the total), 299,000 European Union citizens (26%) and 101,145 Russians (12%). Foreign tourists stayed just over 6 days on average and total tourist nights jumped 23% to 7.3m.

The Ministry of Tourism, whose ultimate aim is to turn Montenegro into a “prestigious,exclusive, upscale Mediterranean destination” for the rich and super-rich , is forecasting a 15% increase in revenues to Euros 550m in 2008, with an increase in total tourist numbers of 10% to 1.27m.

The picture on foreign investment has been equally impressive, with Russians accounting for by far the largest part of all inflows, possibly more than 50%. According to the Central Bank foreign direct investment grew by a whopping 57% to Euros 1bn in 2007, up from Euros 644m the year before. In 2004 it was just Euros 53m.

FDI inflows for real estate purchases, which accounted for just over half of foreign investment, were Euros 514m in 2007, up 53% from Euros 335m in 2006.

However this coming year may not be such plain sailing as its first full year of independence.

The outlook for foreign investment is clouded by concerns that Montenegro’s property market may be overpriced and that the slowdown in the country’s privatisation progamme could continue. Others are nervous that the sharp increase in tourist numbers in 2007 may simply have been a one-off result of the independence effect and the split from Serbia after 15 years joined at the hip.

Continuing problems with poor infrastructure (roads,sewage and water) also are likely to limit fresh expansion of tourist numbers in a nation with a very short coast, a third the size of that of neighbouring Croatia. Hopes of making a swift switch from mass tourism to high-end visitors may be overly ambitious, though few doubt that it is the correct strategy in the mid to long term.

“Why would rich people come to Montenegro stay and eat in a 5star hotel or restaurant, if they cannot wash their hands after a meal. Who wants to swim in a bay, however beautiful, in a country which has no sewage plants,” says one visiting foreigner who believes that ultimately with the right policies and right investments Montenegro could make it as an upscale tourist destination.

Darko Konjevic, executive director of the Montengro Business Alliance, echoes these views: “Montenegro is in a transition process from mass tourism. But it will take time. We are hoping the process of pushing these infrastructure projects through will speed up, as the prime-minister promised at his inauguration last week. We have a big 10% budget surplus of Euros 96m.We can borrow more too. This is really crucial. I mean it can be a nightmare in a town like Budva at the height of the summer season. Last year some 80,000 to 100,000 guests were staying there without water for 14 hours a day”.

The key economic concerns for 2008 and beyond are:

Star project worries: in tourism the country’s two most-publicised projects - the Aman Resorts complex on the country’s signature-island of Sveti Stevan and Canadian Peter Munk’s marina for super-yachts at Tivat in Kotor bay, the deepest inland fiord in the Mediterranean - are both making slow progress and appear to be well behind schedule. If the owners of these two star projects were to lose interest and the schemes were to be downgraded or fail the consequences for the country’s ability to attract sizeable future foreign investment and know-how could be serious.

In addition, the country has yet to get a single internationally-branded five-star hotel on the coast.

Infrastructure bottlenecks: Poor infrastructure is having an adverse impact. Apart from the water shortages, towns and villages along the coast have yet to build a single sewage disposal plant. Driving along the dramatically beautiful, but jam-packed coastal road, was for many a truly disheartening experience in 2007.

Tourist numbers may slip: Good quality accommodation is limited and some analysts believe that tourist numbers might actually fall slightly in 2008. Neckermann, a German travel agency which has been a Montenegro specialist for 30 years and has recently been sending 4,000 foreigners a year to the country, has decided to halt operations in Montenegro because it says the country is overpriced, given the current level of its facilities.

Property sales concern: British and Irish property investors play a significant role in the real estate sector and there are fears prices and sales might be hit by the global downturn in property arising from the US sub-prime credit crisis and fears of an economic slowdown in western Europe. So far this year only hefty interest from Russians - still spurred by high oil and commodity prices - is keeping the scene buoyant. Even here worries over President Vadimir Putin’s attempt to limit Russian investment abroad is causing mild concern.

Almost everyone seems to agree that property prices in Montenegro are on the high side, sometimes approaching levels seen in far more sophisticated and well-developed Italian tourist hotspots. “Even the top-designed apartment blocks in the capital are worth, perhaps as much as two thirds to a half of the Euros 3,000 per square metre currently being asked,” suggests one highly-respected senior foreign banker in Podgorica.

Fears over corruption: an additional worry for foreign and domestic investors is the continuing problem with corruption, particularly at a local level. In a report published in 2007 by the Chr Michelsen Institute of Norway (CMI)*, an independent centre for research on international development and policy, the body said the country’s recent efforts to combat corruption had been “disappointing”. It cited two recent national surveys of small businesses** which showed that “over 50 per cent of entrepreneurs were asked for bribes by various officials”.

To underline the point Freedom House’s Nations in Transit 2007 report*** showed a decline in Montenegro’s ranking on corruption from the previous two years, in large part due to the lack of transparency in the privatisation process, delays in adopting the action plan for the implementation of the Programme for the Fight against Corruption and Organised Crime, and the failure to adopt changes to the conflict of interest law.

In Podgorica a top Western European diplomat admitted there were problems in this area, but he was hopeful change would speed up. “Montenegrins still do not really recognise the validity of the state. For them, protecting and advancing the interests of family and tribe come first. After all they have been a country for less than two years. You cannot expect miracles in this area,” he said.

Privatisation kickstart: the privatisation process badly needs a fresh kick-start. The state is still a majority shareholder in many of the country’s largest companies, including EPCG (Electric Power Supply of Montenegro); Railroads of Montenegro; the Adriatic Shipyard; Plantaze (wine); the Port of Bar; and the Tobacco plant of Podgorica. It still accounts for 64% of the total value of these plants, according to the Ministry of Finance.

Energy dependency fears: Montenegro imports around one third of its power requirements, roughly the equivalent of the energy required to run its biggest exporting producer, the KAP aluminium plant in Podgorica. This has led to a large deficit in the current account of the balance of payments and given that Montenegro has a big potential to tap unused hydropower, wind and sun resources, most energy economists believe there is no reason for it not to be energy self-sufficient in the medium term.

Mixed employment picture: in the last few years joblessness has fallen sharply, but a relaxed work ethic, lack of flexibility in the labour market and skill shortages may become a serious roadblock to economic progress. Seasonal workers from Serbia, Bosnia and Macedonia are already vital to the tourist industry and in the short-term a further easing of work-permit regulations could be vital. A new labour code may be essential.

Says one employer in the tourist industry: “Montenegrins are not always willing to change, or do a job. They love to drive fast cars and drink coffee in cafes on the proceeds of their one-off coastal real estate sales, but this cannot go on for ever.”

Overheating economy: the World Bank and IMF have both expressed fears that private sector credit growth levels of 180% last year are unsustainable and can only lead to overheating and inflation. Some bankers believe this view may be overpessimistic, arguing that the credit figures were from an extremely low starting point and the 2007 inflation rate of 8 per cent was a price worth paying in a start-up economy.

Says Jan-Peter Olters, World Bank representative in Podgorica: “The country’s private sector credit growth last year was the highest in the world. Inflation quadrupled in less than twelve months and it ended up more than double that in most EU countries. It just could not continue. This year the Central Bank has acted to curb it to 40%.”

Less than two years into the life of a nation it is early days yet, however, and Montenegro does have concrete plans to deal with some of the big issues. It hopes soon to finalise contracts for two big highways: a 287km motorway from Bar to Belgrade, the capital of Serbia, likely to cost around Euros 2bn, and another that continues the Trieste Adriatic coastal motorway from its northern border with Croatia through to Albania in the south.

It also has detailed plans to construct a water pipeline from Lake Skadar on the border with Albania north to Bar, due to be completed in 2010 at a cost of around Euros 25m,with an extension further north to the tourist cities of Budva, Tivat and Kotor, hopefully by 2011. It is also in the process of accepting tenders for 43 small hydropower projects, which should help reduce its costly energy deficit.

Many hope the return to power this month of the controversial, but can-do Mr Dukanovic, ( due to remain in office until parliamentary elections scheduled for 2009) will help revitalise infrastructure plans as well as the privatisation programme.

Some argue that a slightly less rapid rate of growth in 2008 might even help create a period of consolidation which could be a godsend for a country in which some are bedazzled by the rapid rate of change.

A slowdown in real estate prices could, they say, prevent a dangerous bubble emerging and allow the government and local authorities to focus a little more strongly on coming up with clear urban and tourist development plans to ensure that the country does not make the same mistakes as Spain and Turkey in ruining a beautiful natural coastline with illegal, unsupervised, unplanned and unattractive developments.

A period of consolidation might also allow Montenegrins to better adjust to their new competitive world, avoiding resentment of the growing band of rich foreigners and locals.

Above all, if this sea-to-mountain paradise is to maximise its growth potential and fully integrate into the European Union and its economy, most outside observers agree it might be wise to concentrate more on speeding up and deepening reforms in the areas of business regulation, law, anti-corruption measures and good governance.

*Richard Cowper is an economist and foreign policy expert, who worked for the Financial Times of London for 30 years. He can be contacted by email at Richard@richardcowper.com

+Corruption in Montenegro. Chr Michelsen Institute (CMI); Marijana Trivunovic, Vera Devine and Harald Mathisen. Report commissioned by Swedish International Development Cooperation Agency (Sida)

**Montenegrin Employers Federation (Unija Poslodavaca Crne Gore): 2006 report; 58% of employers polled felt that corruption at the local government-level was a problem ; 22% of respondents felt that corruption was the greatest obstacle to the growth of the economy; 52.36% of respondents were convinced that it was important to make unofficial payments to local officials in order to get things done, and 57% of respondents felt it was important to give presents to tax and other inspectors.

*** Nations in Transit, Freedom House, 2007. Montenegro scored 5.50 on a scale where 1 represents the highest possible, and 7 the lowest possible rating. In 2005 and 2006 Montengro score better with ratings of 5.25.