Montenegro economy briefing: Inflation and Economic Policy

The previous period was marked by strong price growth. The inflation rate in September was 16%, while the inflation rate in the first nine months was 11.6%. The most significant contribution to the inflation rate during the previous period is the growth of food and fuel prices. Such price trends had a significant impact on the purchasing power of the population, given the drop in real income. The growth of inflation is primarily stimulated by trends on the international market. In order to suppress the consequences of rising prices, the Government adopted a series of measures related to the reduction of excise duties, the reduction of VAT on certain products, the limitation of merchant margins on basic foodstuffs and the limitation of the price of pellets.

Growth of prices represent a significant challenge for the economy. The trends recorded during the current year were reflected both in the purchasing power of citizens and in the operations of companies. A further rise in prices will further worsen the position of citizens. Montenegro reacted by making decisions related to limiting the prices and margins of certain products, as well as by adopting fiscal measures related to the reduction of excise duties and VAT.

Price trends in the first nine months of 2022

During the first nine months of 2022, the inflation rate recorded constant growth. According to MONSTAT data, the total annual inflation rate in September was 16%, which is the highest price growth rate compared to previous months. The average annual inflation rate for the observed period January to September was 11.6%. The inflation rate in September was mostly influenced by the increase in food prices (primarily milk, cheese and eggs for 36.8% and bread and cereals 34.2%, oils and fats 31.9%, vegetables 31.6% and meat 18.2%) and fuel prices (annual price increase amounted to 54%). The increase in the prices of inputs and animal feed for milk production influenced the increase in the purchase price of milk from subcontractors, which ultimately affected the prices of the final product. In addition, the increase in milk prices in the countries from which Montenegro imports milk also affected the level of prices on the domestic market. Also, the trends of the price of cereals on the international market was reflected in the prices of bread and cereals. Considering the continuous increase in fuel prices on the international market during the previous period, fuel prices also increased in Montenegro. As fuel represents a significant element of the cost price of many products and services, it consequently influenced the growth of prices of other products and services, and therefore also the overall inflation rate.

The monthly inflation rate in September 2022 was 1.4%. Compared to the growth rate prices in August, it is higher by 1.2 percentage points (although it is less than the monthly inflation rate in the first part of the year). The price increase in September, compared to August, was most affected by the growth of the process of clothing and footwear (monthly inflation rate amounted to 12.1% and 4.7% receptively), as well as the price of food (prices of milk, cheese and eggs increased by 4.2%, fruit by 4.4%, vegetables by 4.1%) and prices of hairdressing services and other personal care services (6.5%). On the other hand, the prices of air transportation of passengers and accommodation services were reduced by 13.9% and 11%, respectively. This drop in accommodation prices can be explained by the end of the tourist season, so the prices were reduced due to lower demand for tourist services.

The level of prices in Montenegro is largely determined by the trends of prices on the international market. Considering the significant volume of imports, most of the inflation is imported. The rise in prices was primarily stimulated by situation on the international market as a result of the pandemic and the war in Ukraine, which affected market instability. First of all, these events affected the international market with shortages and problems in the supply chains of food products and fuel. Also, the measures taken by the states in order to help companies overcome the crisis caused by the pandemic affected the growth of the money supply, which was inevitably reflected in the level of prices, given that the money supply was not followed by production. The combination of all these factors influenced the growth of product prices. In addition to these, the economic program that began to be implemented in Montenegro at the beginning of this year and which implies an increase in the wages of employees as a result of the change in tax policy has had an impact on the inflation rate in Montenegro. However, this increase in wages was not accompanied by an increase in productivity, and it also affected the supply of money on the domestic market, which was reflected in the increase of prices. For example, by comparing the prices in the EU zone, the trend of which is followed by the level of inflation in Montenegro, before and after the introduction of the economic program, a significant deviation in the price level can be observed since the implementation of the economic program began.

As a result of the rise in prices, the purchasing power of residents has decreased. By comparing the value of the euro in September with the value of the euro during the previous months, a decline in the purchasing power of residents can be observed. Since April, the inflation rate in Montenegro has been in double digits. Since price growth was not accompanied by wage growth, real wages fell. Real earnings in August are almost 4% lower compared to January 2022.

 What measures were implemented in order to reduce the effects of inflation?

Considering the impact of price growth on the purchasing power of the population, their real income, but also the impact on business operations, during previous period, the Government of Montenegro adopted measures related to the change in tax policy, which includes the reduction of excise duty on fuel and the reduction of VAT for certain products. Namely, a decision was made to reduce excise duties by 40% based on changes to the Law on Excise Duties. After a month of application of this measure, the Government made a new decision which reduced excise taxes by an additional 10 percentage points in order to neutralize and mitigate the increase in fuel prices. The decision to reduce excise duty on fuel is in place until the end of October, while its further application will be considered based on the trends of the fuel prices. On the other hand, the effects of this measures are reflected in the reduction of budget revenues.

In addition to this measure, amendments to the Law on Value Added Tax were adopted, which include the temporary abolition of VAT on flour and oil. With these changes, VAT was reduced from 7% to 0% on flour and oil and from 21% to 7% on salt. However, given that there was no mechanism to control the change (reduction) of prices by traders, the effects of this measure are questionable.

An additional measure that was adopted refers to the reduction of the merchant margin on basic foodstuffs. According to the decision, the maximum amount of margin on flour, sugar, beans and salt for wholesale stores is 5%, while the maximum margin for these products for non-retail stores is limited to 7%. In addition to limiting the margin on basic foodstuffs, the Government adopted Decisions on temporary measures to limit the prices of products of special importance, which limited the price of pellets. As energy prices have been significantly increased in order to suppress the negative effects of inflation on the standard of citizens, the price of pellets has been limited to EUR 320 per ton for retail stores and EUR 269 per ton for purchases from manufacturers. As the production of pellets by domestic producers exceeds the needs of the domestic market, the greater part of the production is exported. However, producers are obliged to place 15% of production on the domestic market, while the rest of the production can be exported.

However, controlling or limiting prices can have significant negative consequences for the economy. First of all, it can be reflected in the supply and demand for these goods and services. Determining the price below the one that is freely formed on the market can result in a limited supply of goods, which further leads to product shortages and price increases.

The trend of inflation in Montenegro in the coming period will depend on several factors. First of all, the price level will depend of energy prices level, and stabilization on the energy market, on the other hand, depends on the geopolitical situation and the war in Ukraine. In addition, the decision of OPEC+ to reduce oil production in the coming period may be reflected in the increase in energy prices due to the reduction in supply. As a result, the increase in the price of oil can also affect the increase in the price of other products, given that oil is part of the cost price of a large number of products.

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