Speech of the CBM Governor Radoje Žugić on the Sixth EU-SE Europe Summit entitled “Europe Reconsidered-Can Montenegro Achieve Stability and Growth?”


Historical circumstances and the transition of the entire Montenegro’s social and political system in the 1990s and 2000s resulted in the selection and development of an independent central banking in Montenegro developing in the conditions of full dollarization (Euroisation). With the introduction of the euro as its official currency, Montenegro has reduced exchange rate risk, ensured price stability, reduced transaction costs, facilitated the movement of goods, services and capital with the international community, and opened the road to Euro-Atlantic integration.

Still, the introduction of currency substitution was no alternative to the economic reforms that had to follow in order to transform the economy to the market economy, and to guide future development towards a more sustainable system. This was followed by reforms in all economic policy components: monetary, fiscal, foreign trade, income and others policies, giving the systemic priority to financial stability. Thus, the Central Bank, as one of few central banks in the world, became responsible for preserving the system stability. The selection of full euroisation, deprived us of the function to issue own money, which in turn significantly reduced our monetary policy role and monetary instrument efficiency aimed at adjusting to economic shocks. The result of inability to influence monetary aggregates and interest rates thus transferred fine-tuning to market trend indicators through monetary policy transmission channels to automatic adjustment of economic entities at the market. Despite advantages that currency substitution brought in the pre-crisis period (strong economic growth – with an average of 8.7% in the three-year period, foreign direct investments inflow - with an average of 32% of GDP in the three-year period, banking sector’s growth and development with total banks’ assets and liabilities growth from 35% in 2005 to 111% of GDP in 2007), the shortcomings of such monetary policy became visible when the crisis emerged and the risks arising from the imbalances accumulated during the exponential growth phase materialised.

As an economy of open capital flows, Montenegro’s economy has strongly reacted to the sudden emerging of negative trends in the international market. Moreover, insufficient quality and capacity of institutional reforms, with abnormalities inherited from the previous period, further deepened the already existing vulnerabilities. The scarce own accumulation and competitiveness of the economy, increased by reduced foreign capital inflows, led to the credit risk materialization in banks, increasing business sector’s illiquidity and insolvency, spilling on fiscal risks through the communicating vessels system. During all these growth and decline phases, the central bank used all available instruments to act counter-cyclically. Relying on reserve requirements*, as the only effective monetary policy instrument, was not sufficient, thus we predominantly used regulatory measures to maintain the stability of the entire banking system, as well as those aimed to individual banks. Eight years after the crisis, I dare say that credit risk, as the dominant financial stability risk we faced, has been reduced (NPLs decreased from 25% in August 2011 to some 10% in end-2016).

Still, other risks (although reduced and characterized with positive trends) are still present. Our experience has shown that, in the absence of possibilities to mitigate external shocks using foreign exchange, these effects in the case of a small and open economy are more visible, leading to direct adjusting of entities to market shocks in real time. Such situation requires strong role of fiscal policy. Such deficiency is also present in the countries of the region which, although having their own currencies, have high level of euroisation in deposits and loans, thus the effect volumes are lower in short-term, with the same effect and intensity in the middle-term.

The absence of an independent monetary policy brought such a wider mandate of the Central Bank of Montenegro (CBCG) - maintaining financial stability, with a quantitatively immeasurable objective. According to the Central Bank of Montenegro Law, the Central Bank is responsible for establishing and maintaining a sound banking system and efficient payment system in Montenegro. Thus, the Central Bank primarily has a preventive role in maintaining financial stability and aims to identify certain shortcomings or vulnerabilities in early stages, primarily in the banking system of Montenegro, and also through its role in the Financial Stability Council and its recently acquired mandate for macro-prudential policy in the overall economic system of Montenegro.

Wide competence and responsibility, together with limitations in monetary policy requires the Governor to consider all risks, not only financial, but also legal, fiscal, risks in the real sector, (political), in order to adequately achieve a balance between system stability and efficient regulation. There is a maxim I like to point out, because it is something that I often faced in practice both as a Governor and as a Minister of Finance, and that is that only a sound and healthy debtor is sound and stable in banking terms, thus also making a fiscal system stimulating and sustainable. Therefore, I often highlight the competitiveness of the business environment as a necessary prerequisite for all economic policies efficiency, particularly in the case of small and open economies, heavily exposed to international developments in addition to their own imbalances.

When it comes to bank-centric and euroised systems, a stable financial system is a precondition to establish and maintain a stable economic system. In addition to promoting internal stability, the financial stability in Montenegro also needs to attract foreign direct investment, and encourage development of micro, small and medium-sized enterprises, being important for economic convergence with the European countries.

Following the financial crisis and the decline in the economic activity, numerous central banks pursued different monetary policies, using conventional and nonconventional measures, with a view to fostering economic growth. Nevertheless, the economic growth remained relatively weak, accompanied with low inflation, which indicates that the monetary policy by itself is not sufficient. Thus, the process of adapting the economic system to the given circumstances requires not only the efficiency of monetary policy but also adopting a holistic approach, which implies an interaction of structural reforms, monetary and fiscal policies.  

Finally, the crisis has revealed that the institutions responsible for the financial system surveillance are lacking the adequate rights, instruments for analysis and identification of systemic risks arising from national as well as cross-border sources. Specifically, the crisis has shown that national policy by itself cannot be a guarantee of financial system stability integrated in the wider international environment. Establishing the cross-border cooperation of regulators is essential for the strengthening of the financial system resilience to systemic risk in order to avoid the abuse of national regulatory framework and potential legal vacuums aimed at deriving individual benefits. This imposes a compelling need for strengthening small and consequentially open economies with different monetary policies, however with clearly identical goals.

* Limited monetary policy in Montenegro only includes active use of the reserve requirement instrument. Reserve requirement policy was initially very restrictive, given that the banking system was devastated and non-credible. As the situation in the banking system was improving, this instrument was gradually loosening. The CBCG uses the reserve requirement on bank deposits also for macro-prudential purposes, in order to manage credit cycles and liquidity. In the period before the crisis, the CBCG increased rates on bank deposits to limit excessive credit growth and high indebtedness in the economy, while in the post-crisis period it decreased the reserve requirement rate to encourage banks’ lending activity.