Internship Report at National Bank of Malaysia (BNM)

Published Date: 07 Feb 2018

Introduction

My internship was performed in the Republic of Macedonia, more exactly, at its National Bank.

This institution is the one that deals with the macroeconomic policies applicable in the country. These policies allow a stable and long term economic development of one country.

I opted for Macedonia because it is the country of my origins, and also because I think one day I will be able to work for one of the Macedonians institutions. So this internship will help me find out how these kind of institutions really work, what is the aim of their work.

Macedonia is in a transition process, that undoubtedly is always characterized by numerous difficulties, which are, in general, very similar to other countries living these same processes.

The mail purpose of the government of Macedonia is the integration of the country in some international organizations such as NATO or the European Union.

While its integration in NATO would secure the borders of the country, and a long term stability (as we know that some under ethnic conflicts had risen in 2001), the integration in the EU, which is far more complicated and demands a very high responsibility of the government, will boost the economic development of this small country with a little bit more than 2 million citizens.

The importance of the National Bank, in terms of these integrations, is unavoidable. The Bank is responsible for the monetary policy and economy, for important indexes such as Inflation Rate, CPI (consumer price index), which indexes help to clarify the development of the country in a long term.

The economic stability, and the territorial stability, are two very important things, in order that Macedonia could be part of the big European family, and become a potential country that will attract foreign investments at a much higher degree.

I. Description of the institution

About NBRM

Organization chart

Functions :

the National Bank shall perform the following functions:

• establish and conduct the monetary policy;

• regulate the liquidity in the international payments;

• establish and conduct the Denar exchange rate policy;

• handle and manage the foreign exchange reserves;

• regulate the payment system;

• grant founding and operating license to a bank and a savings house and supervise the banks and savings houses;

• grant a license for performing services of prompt money transfer and supervise the operations of the entities performing services of prompt money transfer in accordance with a law;

• grant operating license to foreign exchange bureaus and supervise their operations in accordance with a law;

• issue banknotes and coins

• perform activities for the account of the central government and the government administration bodies.

THE MONETARY POLICY: Monetary Policy-Design

1. Designing of the monetary policy

The National Bank of the Republic of Macedonia (NBRM) is a central bank, and accordingly, the only bank of issue in the Republic of Macedonia. Its primary objective is to maintain the price stability, thus being independent in the performance of its functions. The National Bank supports the economic policy of the country and the financial stability of the country, without jeopardizing the achievement of the main objective, and adhering to the principles of market economy. In line with the legally set functions, the NBRM designs and conducts the monetary policy at a level of the national economy. At the end of the current year, in line with the previously determined macroeconomic framework, the NBRM works out the Projection of the monetary developments for the following year, adopted by the NBRM Council.

1. Monetary policy goals

The maintenance of the price stability is a primary objective of the National Bank of the Republic of Macedonia, established by a Law. The establishment of this goal is in line with the current EU monetary policy layout, based on the empirically confirmed perceptions that the price stability creates most favorable macroeconomic environment for accelerated economic growth sustainable on a long run. Until 1999, the inflation in the Republic of Macedonia was measured through the retail prices index, while since 2000 it has been monitored by the costs of living index. In order to attain its ultimate goal, the NBRM determines an intermediary target of the monetary policy. Thus from April 1992 to September 1995, the NBRM was applying the strategy of targeting the money supply M1, as an intermediary goal of the monetary policy. Since October 1995, the NBRM has been implementing monetary strategy of targeting the nominal exchange rate of the Denar against the Deutsche Mark, i.e. against the Euro since January 2002. Accordingly, the maintenance of the Denar exchange rate stability is an intermediary goal of the monetary policy. The exchange rate targeting strategy is applied due to the following: a. the importance of the exchange rate in a small open economy (the Republic of Macedonia exchanges around 80% of the GDP with abroad); b. the need of nominal anchor for maintenance of financial discipline and credibility; c. high degree of currency substitution (over 40%) and d. exchange rate transparency and the possibility of daily monitoring by the economic agents.

1. Money supply and money demand

The money supply in the Republic of Macedonia is subordinated to the maintenance of the Denar exchange rate stability, as a nominal anchor in the economy. The amount of money supply is determined in line with the need of regular execution of goods and money transactions, i.e. the economic activity in the country. The money supply is monitored through the following monetary aggregates: M0 – reserve money (currency in circulation, banks' account with the NBRM and cash in the banks' vaults), M1 (currency in circulation and transaction deposits), M2 (M1, Denar and foreign exchange deposits with a maturity of up to one year), M3 (M2 and restricted deposits) and M4 (M3 and Denar and foreign exchange deposits with maturity of over one year). The movement of these aggregates is monitored in line with the adopted projection. The money demand, by the definition, is determined by the income level, the price level and the short-term and the long-term interest rates. On the basis of the previous practical experience, the money demand in the Republic of Macedonia is relatively unstable, primarily due to the transitory and the external shocks, as well as the effect of the currency substitution.

1. Interest rate policy and transmission mechanism

With the monetary policy being directed towards preserving the Denar exchange rate stability, the interest rates and the money supply are endogenous variables, determined by the achievement of the intermediary goal. The NBRM, through its interest rate policy, sends monetary signals to the banks, thus making efforts to influence their lending and deposit interest rates. The lowest interest rate of the NBRM is the discount rate, whereas the highest is the interest rate on the Lombard credit. Currently, the referential interest rate in the economy is the interest rate registered on the CB bills auctions, with respect to its close relation with the interest rate on the Money Market. Due to the higher liquidity in the banking system, no need of organizing credit auctions has been registered over a certain period. However, the transmission canal of the monetary policy through the interest rates in the Republic of Macedonia is still insufficiently developed, considering the insufficiently developed financial market, the rigid interest rate policy of the banks and their insufficient responsiveness to the monetary signals of the NBRM.

DENAR EXCHANGE RATE POLICY

1. Exchange rate policy

According to the National Bank of Macedonia Law (Official Journal of Republic Macedonia nr. 3/2002 & 51/2003), the National Bank of Macedonia establishes and executes the denar exchange rate policy in order to achieve the main purpose – the conservation of the price stability.

1. Current foreign currency system

According to article 33 from the currency policy law, the denar rate is determined by the simple rule of offer and demand for foreign currencies in the currency market. The denar rate in relation with the Euro is fixed by the reports from different banks that take part in the currency exchange market. As for the other foreign currency, the rate of the denar is determined by the relation between these currencies and the Euro rate, which is fixed by the European Central Bank. The buying and selling rate is calculated with the addition and deduction of 0.5%. In fact, this is the way how the National Bank of Macedonia exposes every day the approved currency rates on the Currency List.

1. The execution of the currency policy

According to the denar rate targeting strategy, as an important element, the goal and also hard task of the monetary policy is to keep stability between the denar and the Euro rates. If there are tendencies to the depreciation or appreciation of the denar, the National Bank interacts by selling or buying respectively, foreign currencies, after what the monetary strategy becomes respectively more restrictive or more expansive in relation to the projected targets.

1. Relationship between the monetary and the currency policy

There is a huge dependence between the monetary and the currency policy. It is important for the Macedonian economy to keep a stable exchange rate with the euro, in order to keep price stability in the country, which element will lead to a better life for all its citizens.

In October 1995 the monetary targeting strategy was overturned, and a new strategy was embraced, called the targeted nominal denar rate strategy. With this new strategy, the rising of the money supply is transformed into an instrument that helps, directly, on the stability of the currency rate, and indirectly, on the price stability.

1. Currency reserves

When the Macedonian National Bank became independent, it had no currency reserves at all. It all began in 1992, when the National Bank began creating its own reserves. The amount of foreign currency reserves is rising permanently. While in 1992, there were around US $60 million, it became US $803 million in 2003, which represents the amount of four months of import.

According to article 25 from the Law on the National Bank of Republic of Macedonia, the management of the National Reserve is in the hands of the National Bank itself. It has also to duty to prepare and consolidate reports every 6 months.

On behalf of the management of the National Reserve, the National Bank, according to article 28, is loyal to the principles of awareness, liquidity and profitability.

• The exchangeability concept

The Macedonian currency has a present exchangeability. In June 1998, Macedonia has accepted article nr. 8 of the International Monetary Funds' Statute, which stated that all currents transactions between residents and non-residents can be completed freely, without restrictions. As part of this agreement between the National Bank of Macedonia and the IMF, was also the liberalization of capital transactions.

The direct investments of residents abroad, and of non-residents in Macedonia, are now free, except of a taxation fee in order to register by the ministry of economy. Non-residents can now invest into any Macedonian company, to start their own companies, and to buy shares so that they can become shareholders of all enterprises listed on the Macedonian Stock Exchange (MSE 10). The profit and all the capital investments can be taken back to the non-residents' place, if there are no more liabilities towards the government.

Non-residents, on behalf of diplomats, and other embassy representatives, have the right to buy real estate, but under certain conditions of demand and registration at the Central Registry of Macedonia.

Residents may distribute and sell native shares at foreign financial markets if he/she has the permission from the Commission of shares and financial instruments.

Credit transactions are also liberalized, in and abroad the country, so that the funds can move loosely, but for that, the National Bank needs to be informed.

Residents may use foreign currencies obtained from transactions made with a foreigner to clear any debt he has, or also use them in the currency market to exchange them into the national currency. In order to pay with a foreign currency abroad, a resident may “buy” these currencies in exchange offices. Other residents, such as physical persons, can also exchange their money for other purposes, not only for business. As for the opening of an account abroad, residents need to be authorized by the National Bank itself.

It is possible for any non-resident to open a denar or foreign currency account, and to use it whenever he/she wants to, with no objection. But there is a limitation on the amount of payments a month, this limit is 10.000 Euros.

But, in case of disorder of the balance of payments or the financial system, the National Bank can prevent the circumstances to worsen by application of some restrictions.

PAYEMENTS SYSTEMS IN MACEDONIA

General Features of the Payment System

The payment system represents a sum of instruments, procedures and infrastructure for money transfer. It is of great importance for all economic agents since it enables fast and efficient payments in the national economy.

The payment system of the Republic of Macedonia can be presented schematically as:

The central bank, which runs the accounts of the deposit money institutions – the banks, is at the top of the payment system. In the payment system, the central bank has the following functions: operational, development and function of monitoring of the other payment systems in the country.

The banks, which run the accounts of other legal entities and natural persons, consist the following level. Running of the accounts is decentralized – which means, each bank runs only the accounts of its clients. In order to execute and perform prompt settlement of the large value payments and urgent interbank payments, the system of the central bank is used. For netting the small value payments, a specialized institution – the Clearing House for small value payments is used, while the results of the netting are later settled in the system of the Central Bank.

Start of the New Payment System

On July 30, 2001, the functional implementation of one of the most complex reforms in the Republic of Macedonia, the Reform in the Payments System, commenced. This Reform is managed by a Steering Committee comprised of experts from the National Bank of the Republic of Macedonia, the Ministry of Finance, the banks, the Payment Operations Bureau and eminent professors from the Faculty of Economics in Skopje.

This start represents a beginning of a new payment system designed according to the payment systems of the countries with developed market economies. The new payment system enhances the competitive component of the banks and represents a prerequisite for implementing new banking products which increase the efficiency of the banks and the banking system as a whole. The competitiveness induces new IT tendencies in the banking operations. The reform enables more efficient monitoring and management of the liquidity of individual banks, as well as better efficiency in conducting the monetary policy.

The previous payment system (effective until December 31, 2001) incorporated strong static components and limitations both regarding the options, as well as technological limitations, which represented an obstacle for the future development of the financial infrastructure and the financial system as a whole.

The implementation of the new payment system was encompassed a transitional period from July 30, 2001 until December 31, 2001, during which besides the implementation of the new systems, the Payment Operations Bureau continued with its operations as a specific payment system.

The National Bank of the Republic of Macedonia has important functions in the new payment system, which are stipulated in the new Law on Payment Operation.

BANKING SUPERVISION

According to the Law on the National Bank of the Republic of Macedonia and the Banking Law, the National Bank of the Republic of Macedonia is the only supervisory authority responsible for licensing and supervision of banks and savings houses in the Republic of Macedonia.

The main purpose of the supervisory function performed by the National Bank of the Republic of Macedonia is the maintenance of safe and sound banking system and protection of the depositors and other creditors that had invested their money in the banking system. The National Bank of the Republic of Macedonia has established supervisory standards that are incompliance with the international standards and practices set by the Basle Committee on Banking Supervision.

Supervisory standards

While performing their activities, banks are obliged to comply with the existing supervisory standards that are implemented for the purpose of limiting the banks' risk exposure. The supervisory standards established and implemented by the National Bank are derived from the Basle Committee's principles and the European Directives. The most important standards implemented by the National Bank are:

• capital adequacy, i.e. maintenance of an adequate capital base that will enable covering of the risk profile of banks. The capital adequacy ratio calculated as a ratio between the bank's own funds and its risk weighted assets, must not be lower than 8%;

• criteria for classification of on-balance and off-balance sheet asset items of banks according to their risk level and determining adequate amount of impairments and special reserves for coverage of the banks' potential and/or established losses;

• exposure limits as a ratio between the total on-balance and off-balance sheet exposure to a single persons and group of connected persons and the bank's own funds;

• limits of exposure to the FX risk and the manner of managing this type of risk;

• limits on investments in land, buildings, equipment and equity holdings.

ISSUE COINS AND BANKNOTES

1. Legal Tender in the Republic of Macedonia

Legal tender in the Republic of Macedonia is the Macedonian Denar, consisting of 100 Deni. The National Bank of the Republic of Macedonia has the exclusive right of printing and issuing banknotes in the Republic of Macedonia.

Macedonian banknotes in circulation (issue 1996 and 2003) :

· 5000 Denars - issue 1996

· 1000 Denars - issue 1996 and issue 2003

· 500 Denars - issue 1996 and issue

· 100 Denars - issue 1996

· 50 Denars - issue 1996

· 10 Denars - issue 1996

2. Printing and characteristics

The lower banknote denominations of 10, 50 and 100 denars are printed in Macedonia, while the banknotes of 500 and 1000 denars (1996 issue) are printed at “Thomas de la Rue”, London. The last banknote issue of 2003, 500 and 1000 denars denominations, was also printed in TDLR. The Macedonian banknotes posses several security features like watermark, windowed-thread, intaglio print, latent image, micro-text, see-through feature, and optically variable ink.

3. Institutions which Act as cash collectors

Institutions which act as cash collectors are the National Bank of the Republic of Macedonia and commercial banks.

II. Internship description

As I am from the Republic of Macedonia, I thought maybe doing an internship there would be a plus for me. I graduated in Macedonia in 2002, so I really wanted to go back there to an internship, which I think it was a good idea in order to put together what I've learned at university and what's happening in the real life out there.

I think it is crucial for a student, or a future graduated student, to learn and make the link between theory and real life practice in order to get ready and not surprised or shocked when first meeting life for real.

The reason also why I chose Macedonia to complete my internship, is that one day after graduating in Belgium, to be able to go back there, and work for my country, which would be much easier if the internship was done there, especially at a very important institution, its' National Bank.

But, it is also important to say that in this kind of countries, it is difficult and complicated to find a company, private or public, that would accept a future graduated student to do his/her internship there. This is also the position of national institutions.

In such countries, that are living in transition, and where this process takes so long, and has many difficulties, the problem of informal economy is very present in the everyday life. This is the reason why, it is so hard to find a company that would offer you a normal and proper internship, unless, of course, if you may know the head of the company or institution.

I was, unfortunately, not in this case of knowing somebody “important” to either private or public institutions. Regardless this fact, I still applied and send the demand of such internship at the National Bank of Macedonia. It took very long to get a response from them, but it finally came positive.

After this, they were some complication, especially during the 2007 summer, for me to begin with the internship. In fact, there were some procedures to respect, which were not told to me and which I didn't know. Above all, the extreme heat of that summer had an impact on the government to reduce much of the working hours, especially in its institutions. That is the reason why I could not manage to start the internship that summer.

My internship could finally be done during the three months of holiday granted to last year students at ICHEC. I was accepted by the human resources manager at the Bank, who interviewed me, especially to learn about my background, such as school, political, interests on the National Bank, and so on. After that I could finally begin with the internship.

I was told to begin the very next day, after signing a convention of behavior at the Bank. I was supposed to start at 8 am and finish at 4 pm, which is the work time of each functionary working at this institution.

After the interview, the Human Resources Manager advised me, in relation with my interests, to do the internship in the Research and Development department of the National Bank.

It was a little confusing, because in general, students are allowed to come for their internships a few hours during working days, while I was invited to go there all day long. It was a something I didn't expected at all when I applied for this internship. But the conditions were given by them, so I did not wanted to react about that. But it was not the best manner to execute and learn about my topic.

When I begun the internship, I had the task to read the reports that are issued by the National Bank itself. Actually, I didn't understand why I had to do this, but everybody told me they had done so when they started work at the Bank. It was also the way internship students started at this institution. It was a little confusing, but I had to rely on this task.

This reading of the reports helped me though to learn further more of the different indexes that are studied, and their importance in order to measure the development of the macroeconomic policy of Macedonia. But I would have been more satisfied if I was told before beginning this internship to do so, in order to not waste my time reading during my internship, which was limited in time.

First, I had a topic that seemed very clear and comprehensive to me. But after a few days at the Bank, I understood that something had to be changed in this topic because as I was entering my internship everyday more and more, I could see that my topic was too vast, and it could not really help me for my final paper, which would be related with the internship.

After many consultations with my internship advisor, and also with participation of the head of the sector, I decided to somehow change my topic.

At the beginning, I was opting for a study about the macroeconomic indexes, such as Inflation Rate, Unemployment Rate, CPI (consumers' price index), etc. These indexes are studied and performed by the National Bank of course. But as I said, it was really a vast topic, which could have gone nowhere, and finally not helped me much to the purpose of the internship.

So I opted for a change. This change was more directed towards the energy sector of Macedonia, and how energy has an influence on the economy of this country. This idea came, as I said, after consulting people working there, but above all, after attending on a presentation performed by a professor of the Cyril and Methodius University of Skopje for the National Bank.

The professor presenting was Dr. Vlaško ÄŒingoski, and the topic: The Electro-energetic Situation and Perspectives of Republic of Macedonia. The presentation was mainly on the problems concerning the energetic sector of Macedonia, from its independence until today, the current situation of energy and also the most probable and real manners to overcome the negative balance on this sector. This presentation really opened my path, and helped me a lot into finding a new and more specific topic for my final paper.

Other presentations regarding energy, and the energetic sector concerning Macedonia were performed after. I attended all of them, as my interest was since balancing toward this topic. I was allowed though to be present at these meetings, so it helped me further more in my focusing. The other presentations were performed also by professors, or people working in the management of electro-energetic companies.

But my internship wasn't all about attending presentations, and taking notes of them. As I said, I was accepted at the Research and Development department of the Bank. This department, which was the one where my main advisor worked, is the principal responsible for the construction, consolidation, editing, and writing the annual, trimester, monthly, and even two-weekly reports concerning the development of the economical situation of Macedonia, and comparing them to other countries, mainly from the Balkans.

These reports have different parts, in general. The first part, concerns the economic development in a global point of view. Next we have the development of Macedonia, then the monetary development, the capital market, etc.

Generally speaking, they are specific teams that work on a specific part of these reports, but the teams can sometimes change. My main advisor was more active on determining and calculating macroeconomic indexes, and then, comparing them with the same indexes of one specific period of last year, or same periods in the past. That was in general his role, and the one of his team.

In fact, I was introduced at his computer to see how things are going, working thus with these indexes. All indexes were calculated via Microsoft Excel, and a software, which is frequently used by National Banks in the region and wider, called eViews. I was not able to have this software on my computer, as it is a program only the National Bank of Macedonia may use. This is why I couldn't really get deep into this software, in order to understand how it works, and what data or information it offers.

So, the whole things was to take right data, transform and calculate them into indexes, compare them with same indexes of past periods, design different graphics and tables so that it is more comprehensive to the reader, and finally do the interpretation of the results.

The data I mentioned before, which are the base of these indexes, are delivered from the Statistical Office of Macedonia. It is this office that has almost all statistical data for the population living and working in Macedonia. It also has information about the housing sector, which is important to calculate some indexes, such as inflation and CPI.

Then, I was able to start and calculate myself some basic and simple indexes, but mostly, I was asked to compare them with the past permofmances. This is not a very difficult task to do, as I have had many statistical classes during my study years both in Macedonia and Belgium.

But I have to say that, my internship was far from what I was expecting. I am conscious that the period I was able to do the internship, was a full working period. Everybody there was working at high speed to finalize the annual report of 2007, which is the most important, and also most voluminous of all. So, they had not very much time to spend with me and my internship.

In general, this internship enabled me to see what the sector works in real terms, and also, it was very important for me that I was able to have access to the Banks' library, and also to many publications that I saved, which helped me analyze the data that interested me more after I was done with the internship.

III. Technical Part

Introduction

As I mentioned in the introduction of this internship report, I was first keen on studying the macroeconomic indexes that the National Bank of Macedonia uses in order to develop its' reports (annually, monthly, even 2 weekly reports) that are required by many organizations such as World Bank, the ECB, the International Energy Agency, etc. But after some time, I realized I should be focusing more on one specific matter, and that was the energetic sector of Macedonia.

I think the problem of energy, globally speaking, is becoming more and more an important issue, that is undoubtedly an unavoidable factor for the economic growth and development of one country.

Especially, in countries such as Macedonia, who aren't very rich in natural resources, this situation can have a huge impact, having in mind that these countries are highly dependent on the import of energy producing products.

The reason why I chose this topic to study is, that it is a problem everybody talks about in these days, as we are conscious of the high prices of oil in the recent months. This is another important factor that pushes the issue of the Macedonian energetic sector just further.

This study provides an overview of the investment and policy choices in the Macedonian energy sector. On the investment side, the study highlights the criteria under which potential investments in a new Combined Heat and Power (CHP) plant and a new coal mine should proceed. The Report focuses on reforms that would be required to support the CHP project, namely ratification by Macedonia of the Kyoto Protocol and resolution of ownership issues related to the gas pipeline linking Skopje to Bulgaria. The report recommends development of a Skopje gasification project, and a Renewable Energy Project. Regarding reforms to support Macedonia's participation in the regional energy market, the Report concludes that good progress is being made, particularly as regards development of a regulatory framework for the energy industry. The Report recommends that ESM is restructured prior to privatization, with hydro assets being separated from thermal generation, and possible ownership separation of thermal generation and distribution. The Report also questions the economic viability of the Skopje oil refinery, and recommends that a review of this is undertaken.

ENERGY SECTOR OBJECTIVES

Macedonia has recently made significant progress in energy sector reform, most notably through adoption of an Energy Law and establishment of an independent energy regulator.

Notwithstanding this, further progress is required if the following objectives – agreed between the Government of Macedonia (GOM) and the World Bank – for the Macedonian energy sector are to be met:

• to provide secure and affordable energy on a sustainable basis;

• to commercialize the energy industry;

• to improve energy efficiency in Macedonia; and

• to improve environmental performance of the Macedonian energy industry.

These objectives derive from the broader goal of the Macedonian government to promote macroeconomic stability and growth whilst protecting poor groups in the population.

Successful implementation of energy sector reform will support: reduction of the fiscal and quasi fiscal budget deficits; provision of reliable and competitively priced energy to Macedonian industry; provision of affordable energy to residential consumers.

Fulfillment of energy sector objectives outlined above is very important and covers the power, heating, gas and oil sectors.

Outstanding energy sector challenges fall into two broad categories: those relating to maintaining energy balance, and reform challenges.

Challenges relating to the energy balance derive from the first three objectives above. Reform challenges derive from all four objectives.

Domestic primary energy resources in Macedonia comprise lignite and hydro power. Crude oil is imported through a pipeline from Greece and refined in Macedonia and in addition some products are imported. A small amount of natural gas is imported from Russia through Ukraine, Romania and Bulgaria. Regarding secondary energy, there is a potential domestic power capacity imbalance in the medium term.

Going forward, lignite supplies from working mines will become exhausted in the medium term. This is a crucial point given that currently around 70 percent of power is currently generated from lignite, and power is used extensively in the residential (often for heating) and industrial sectors. In addition, energy demand has increased in recent years, a trend that is likely to continue given forecast macroeconomic growth. In these circumstances, action is required if energy balance is to be maintained.

Options for maintaining energy balance include:

• Opening of new seams in existing lignite mines/opening of new lignite mines;

• Addition of gas fired power capacity;

• Increasing power imports;

• Reduction of losses in power distribution; and

• Increased gasification through construction of new gas distribution networks.

This study provides a framework for determining which of these options are economically viable/beneficial.

The main messages in the study as regards energy balance are:

• The Government of Macedonia should support the most economically beneficial investment projects from the various alternatives.

• This (economics based decision making) neither a priori prefers, nor precludes, the use of domestic primary resources for energy supply.

• A feasibility study is required to confirm the economic benefits associated with exploitation of new mine seams/new mines.

• A feasibility study is required to establish the economic viability of the proposed Skopje CHP plant.

• Should the study demonstrate viability, a strategic investor for the project should be selected through an international competitive tender.

• In order to support the project, the Government of Macedonia should sign the Kyoto protocol, and resolve ownership issues related to the gas transmission pipeline.

• If the project is shown to be not viable, it should not proceed; the CHP plant would become a stranded cost for ESM (the national power utility) in these circumstances.

• ESM should develop a project for reduction of losses in power distribution.

• A Skopje gas distribution concession project should be developed.

• Further work is required to evaluate the economic benefits of new gas pipelines which would facilitate transport of Caspian gas through Macedonia to western Europe.

It is implicit in the above that the study does not elaborate a detailed investment program (as would, say, a least cost expansion plan for the power sector). Rather, it reviews existing work that has been done, and identifies gaps where further work is required, in order that an investment program can be developed.

The World Bank recognizes that the Government of Macedonia may choose to incorporate other factors (e.g. political, social) in its decision making as regards energy sector investments. One key area will be the extent to which Macedonia relies on the regional energy market for supply of primary (gas) and secondary (power) energy.

To reiterate from other considerations (e.g. political), and focuses on economics as a basis for decision making. Decisions based on economic criteria would be optimal from the perspective of Macedonian energy consumers (residential and industrial) and taxpayers.

Regarding reform challenges, it is necessary that further steps are taken in order that secure and affordable energy supply is sustained. Steps relate largely to implementation of the Energy Law as amended, and cover development of the energy sector regulatory framework (particularly as regards secondary legislation for pricing), commercialization and restructuring of ESM, and energy industry ownership.

It is recommended that the energy sector reforms are to be deemed appropriate in the Macedonian context. Proposed reforms are consistent with requirements under the Athens Memorandum establishing the South East Europe Regional Energy Market (SEEREM), to which Macedonia is a signatory (discussed in section 3.2 below).

The main messages of the paper on the reform side are that:

• Power tariffs should be increased in real terms as investments are undertaken.

• ESM and the Government of Macedonia should adopt and implement a plan for reduction of power sector losses.

• One major challenge for the new independent energy regulator is the development of tariff methodologies for the power sector.

• Generation, transmission and distribution businesses of ESM should ideally be separately owned following restructuring, unless there is a signal from the market that some cross ownership will be required to stimulate sufficient investor interest.

• Thermal generation should be privatized on a stand alone basis (i.e., it should not be integrated with hydro generation or distribution, and subject to the proviso above on cross ownership).

• Distribution should be organized as one company (if the objective is for privatization to an international strategic investor).

• Macedonia should establish a power market surveillance function, though this need not be a standard market operator.

• Pipeline and trading activities of Makpetrol should be separated.

• Secondary legislation for the gas industry should be developed.

ENERGY BALANCE

This section of the paper explores options for maintaining energy balance. Given that the primary energy balance is dominated by coal produced almost exclusively for use in power generation, together with hydro power production, power balance is the key determinant of energy balance in Macedonia; energy balance data is presented in Table 1. For this reason, the section starts by focusing on the power sector. Noting that energy intensity is high in Macedonia, the section proceeds by examining measures to reduce energy demand, as listed in Chapter 1 above (reducing power distribution losses, etc.).

Power Sector

Installed power generation capacity in Macedonia is 1450 MW, comprising approximately 60 percent thermal and 40 percent hydro plant.

The main thermal generation plant – “Bitola” – has three units each of 225 MW, commissioned starting in 1982 with planned retirement/rehabilitation from 2013. In addition to Bitola, there is a 120 MW lignite fired plant – “Oslomej” – due for retirement in 2013 and a 210 MW oil fired plant – “Negotino” – which, due to prohibitively high fuel costs, has been used very rarely since it was commissioned in 1978. There are also seven large hydro plants in Macedonia with combined capacity 480 MW, and a numberof small hydro plants with total capacity around 50 MW.

Forecast power demand and supply are presented in Table 2 above. On the supply side, the table assumes that there are no new additions to capacity and that plant (specifically Bitola and Oslomej) is retired at current planned dates. The table shows supply for two scenarios: the first scenario assumes that, whilst available, Negotino is not dispatched due to prohibitively high costs; the second scenario assumes that Negotino is dispatched, and is included to illustrate the extent of Macedonia's power import dependency (for example, whilst Macedonia's power imports in 2008 may be close to 30 percent, because it is cheaper to import power than to operate Negotino, it need only import under 15 percent).

The table shows that, absent investment in new capacity and new fuel sources, a capacity imbalance will emerge in the medium term, and that by 2013, should Bitola close, Macedonia would be almost wholly dependent on imported power.

It is unlikely, however, that this situation will ensue in reality, given the various investment options open to Macedonia, which include: opening new lignite seams in existing mines/new lignite mines and – later – rehabilitation of Bitola; investment in new gas fired capacity; and increased power imports.

These are now considered in turn, based on the assumption that the Government of Macedonia will aim to select the most economically beneficial investments from available alternatives.

Maintaining Current Capacity/Bitola

One key issue as regards power balance in Macedonia is fuel supply to the Bitola power plant. This plant currently consumes 6.5 million tones of lignite annually from the Suvodol mine, where remaining reserves in the upper seam are around 60 million ton (i.e. enough to fire Bitola for another nine years [to the end of the design life for the first unit of the plant]).

A study carried out for ESM by Harza in 2000 suggested that exploitation of deposits in the Suvodol lower seam (where reserves are estimated to be around 36 million tons), and from a new mine (“Brod Gneotino”, with estimated reserves of 43 Million tons), together with rehabilitation of Bitola from 2013, would be economically beneficial. this would partially close the capacity imbalance shown in table 2 above.

The study proposed that equipment from the Suvodol upper seam should be transferred to exploit reserves in the lower seam and at Brod Gneotino, once the upper seam is exhausted. In this scenario, imported lignite would be required to fire Unit 3 of Bitola following rehabilitation to be competed in 2020.

An alternative would be to begin mining of the Suvodol lower seam and Brod Gneotino earlier, postponing the need to import lignite beyond 2020. To the extent that this would require purchase of extra mining equipment, the study suggested that it would not be economically beneficial relative to the case where equipment is redeployed from the Suvodol upper seam.

Since this time, further work on feasibility has been carried out, both by Exergia for the Government of Macedonia, and by ESM. Whilst this work suggests that mining the lower seam of Suvodol would probably be economic, mining of Brod Gneotino is likely to be marginal from an economic point of view. In fact, further work is required to determine the extent to which mining equipment could be shared, and to which new investments would be required in order to exploit Suvodol lower seam and Brod Gneotino.

To this end, the Government of Macedonia has in 2004 commissioned a Bitola Fuel Supply Feasibility Study. The study will estimate the levelised cost of mining Suvodol lower seam and Brod Gneotino under various scenarios, and provide a view on the economics of starting to exploit these mines now and in the future.

From an environmental perspective, implications of mining the Suvodol lower seam would be very limited, given that the Suvodol mine is already in operation (i.e., there would be no need to create a new mine or disturb new land). Whilst there would be some increase in dumping of waste material as the lower seam is mined, this could be dumped back into the existing open pit.

Regarding Brod Gneotino, environmental ramifications of exploiting this new mine could be significant, in terms of disturbing land and waste disposal. In addition, mining Brod Gneotino would result in increased dust production, and would require pumping of water from the mine (which would be below the water table) into an adjacent river. Any decision to move forward with exploitation of Brod Gneotino would have to account for these potential consequences, and elaborate mitigation measures.

Should the Bitola Fuel Supply Feasibility Study show mining of Brod Gneotino to be uneconomic, and assuming that the Government of Macedonia is pursuing economic – rather than political [e.g. to maintain employment in the mining industry] objectives, then alternatives of replacing Bitola with imported coal fired/gas fired generation from 2013 should be considered through a new feasibility study. Such a study would consider the costs of rehabilitating Bitola to run on gas rather than coal/adding new gas plants elsewhere in the country/importing power.

Should the feasibility study show exploitation of new seams and/or new mines to be economic, ESM should proceed to develop a Bitola fuel supply project; ESM has had preliminary discussions with the World Bank on this issue. It should be noted, however, that – irrespective of whether the World Bank is able to provide funds - there is a potentially large finance gap relating to the proposed Brod Gneotino project.

Options for Meeting/Managing Rising Power Demand

2.3.1 Investments in power generation/increased power imports

In order to meet forecast increasing power demand, either investments in new power generation capacity or increased power imports will be required no matter how Bitola is supplied with fuel.

One candidate for investment in power generation is a new 200 MW Combined Heat and Power (CHP) plant to be constructed in Skopje.

A study carried out by the Japan Consulting Institute in 1999 suggested that a CHP project in Skopje would have a favorable economic rate of return. This study did not, however, compare the project with the alternative of increasing power imports. In addition, the assumed gas price in the study of US$85/tcm has increased to around US$150/tcm currently.

The Harza study (discussed above) argued that a CHP plant would enter the least cost expansion plan for the power sector. This relied, however, on there being limited capacity for power imports. Subsequently Macedonia and Bulgaria have reached agreement on construction of a new transmission interconnection between the two countries, and a project is now under implementation; thus the Harza assumption on power imports is no longer valid. In addition, gas prices have changed significantly since the Harza study was carried out in 2000.

Recognizing the need to update previous work, the Government of Macedonia has in 2004 commissioned a Skopje CHP Feasibility Study. This will explore the economic viability of the proposed CHP plant vis a vis power imports and the possibility of converting the Negotino (oil fired) plant to run on gas or imported coal. The study will assess whether there is an economic rationale for a CHP plant and, if so, when such a plant should be constructed.

The feasibility study should be completed by the end of the second quarter in 2004. Assuming that it supports the proposed CHP project (i.e. demonstrates that it would provide power at lower cost than alternatives) a number of actions would be required.

Given the Government of Macedonia's constrained financial resources, construction of the CHP plant would have to proceed as a private project, sponsored by a strategic investor and commercially financed. To this end, the Government of Macedonia should appoint an adviser to select an investor through appropriate / transparent procedures.

The adviser would draft gas supply, power and heat purchase contracts for the CHP plant, together with bidding documents for an international competitive tender. The adviser would work with the Government of Macedonia, providing support in carrying out the tender (issuing request for proposals, technical evaluations, financial evaluations, etc.). It is likely that this process could be completed, and an investor selected, by the end of 2004, or early in 2005. The financing package, to be determined after the tender is resolved, may or may not include International Financial Institutions – who could potentially offer equity, debt or guarantees – as required by the investor.

In order for the CHP project to be viable, it is highly likely that the strategic investor would need to be able to benefit from related carbon credits, which in turn would require that Macedonia signs the Kyoto protocol. In addition, a baseline emission analysis should ideally be carried out prior to the tender process; this would clarify the quantity of potential carbon credits related to the project.

It is likely also that project viability would require a reduction from the current gas price in Macedonia. Either the Government of Macedonia/or Makpetrol should negotiate to this end, or the tender process should be organized to give the selected investor an incentive to negotiate a lower gas price. In addition, gas pipeline ownership issues (discussed in section 3.4 below) should be resolved as a matter of priority.

2.3.2 Investment in power distribution

The power distribution network in Macedonia suffers from a lack of investment in previous years. Aging equipment is partly responsible for distribution system losses estimated to be 17 percent of power available. This is a figure which is high by western European standards. Failure to remedy this situation - through investments to rehabilitate and upgrade the distribution network - would result in increasing losses and declining system reliability, particularly in a context of demand growth. Conversely, investment in the distribution network should help to reduce the capacity imbalance in Macedonia (because the electricity would no longer be lost but could be used).

A feasibility study for distribution investments was undertaken for ESM by Harza consultants. The study suggested that a US$60 million investment would yield a loss reduction equal to 4 percentage points, or around 300 GWh of power annually. The associated economic rate of return is in excess of 20 percent - significantly higher than returns associated with generation projects – makes investment in power distribution a priority for the power/energy sector.

In addition, distribution loss reduction would have associated environmental benefits in the form of reduced emissions (sulfur dioxide, nitrogen oxide and greenhouse gasses) relative to a counterfactual of higher thermal power generation to maintain energy balance.

Recognizing this, the Government of Macedonia and ESM are working together with the World Bank to develop an energy project which will include a significant power distribution loss reduction component.

2.3.3 Energy efficiency

Macedonia has a considerable untapped energy conservation potential, unlocking of which would help to maintain energy balance. The strongest indication of this potential is to compare the energy intensity expressed as total primary energy production divided by the GDP. Table 2.3 below shows that the energy intensity in Macedonia is on a level comparable with that of its non-EU neighbors but much higher than that of countries of the EU. Even when GDP is adjusted for Purchasing Power Parity Macedonia's energy intensity is about 50 percent higher than that of neighboring EU countries like Austria, Italy and Greece.

 

The reason for the high energy intensity can be traced to: i) heavy use of energy in metal processing industry; ii) low-efficiency power generation, supply and consumption; and iii) the prevalence of using electric energy for residential heating during the winter.

Studies have indicated that opportunities exist for improvement through adoption of well-proven and readily available technologies including efficient appliances, controls and insulation. Application of these technologies on a widespread basis would not only reduce energy demand and help postpone future investments in new generation capacity but would also reduce emissions.

However, a number of barriers are hampering the investment in energy efficiency (EE) projects, most notably: (1) lack of awareness, information, and confidence on the part of Small and Medium Enterprises (SMEs), Government/budget entities, and residential consumers, on the efficacy of EE investments and technology; (2) lack of capacity in EE project development, including engineering, installation, and monitoring of energy efficiency measures; (3) lack of understanding and capital available through Financial Institutions (FIs) for EE investments; and (4) perceived risks of EE investments by FIs.

The GOM is presently considering embarking on an Energy Efficiency and Renewable Energy (RE) Strategy in order to increase EE/RE investments in the economy. The thrust of the initiative would be to improve the investment climate for EE and RE. The World Bank is providing support through a new GEF grant project, with the objective to remove barriers for investments in sustainable energy, defined as energy efficiency and renewable energy. The GEF project will support development of the Energy Efficiency and Renewable Energy Strategy.

2.3.4 Renewable energy

Macedonia has promising indigenous resources of renewable energy. These include hydropower, geothermal energy, biomass energy, and in the longer term wind energy. However, even though a pipeline of financially viable renewable energy projects has been identified by different project developers, these are not being implemented because of institutional and financial constraints.

The GEF Mini Hydro project that will be completed by the end of June, 2004, has demonstrated that financially viable opportunities exist for tapping of small hydropower resources, e.g. by adding small turbine plants to existing water supply pipelines. For the purpose of following up on this project, the Ministry of Economy has developed a “pipeline” of 4 similar projects (each in the rage of 0.5 to 5.0 MW) proposed by public sector entities and 11 mini-hydro projects (each in the range of 0.1 to 1.0 MW) proposed by private investors. These projects have all been screened for technical and financial viability, but they mostly still face institutional constraints (e.g. the solving of water rights issues) and all suffer from limited access to finance.

The Macedonian Geothermal Association has prepared a list of eight projects for expansion and rehabilitation of the existing geothermal schemes in Macedonia, mainly for use of geothermal heat in greenhouses and for space heating. The projects appear to be financially viable (pay-back time less than seven years) but many face substantial institutional problems (e.g. public ownership of the near-bankrupt spas that own the existing boreholes).

ESM is interested in developing a measurement program to determine the potential for wind energy in Macedonia. Such a program would need to be put in place before it would be possible to estimate the financial viability of wind power in Macedonia.

In Kavadarci, center for the wine production in Macedonia, there is interest in projects to prepare fuel briquettes from vineyard waste. The project sponsors have calculated that at current energy prices such a project would have a pay-back time of five to six years. Several other options for biomass use exist.

Removing barriers for use of these renewable energy supply options would increase the supply from indigenous energy sources, create local employment options and mitigate the adverse environmental impact of energy production. The World Bank will assist the GOM in the removal of barriers for renewable energy as part of the new GEF project.

District Heating

District heating in Macedonia is largely confined to Skopje14, where there is currently 487 MW of hot water generation capacity and 26 MW of steam capacity. Annual heat production is around 685 GWh, predominantly for residential and commercial consumers. System losses of around percent are not unduly high by regional standards, although there may be scope for economically viable loss reduction projects.

A study carried out by Exergia for the Government of Macedonia suggested that scope for extending the Skopje district heating network is limited. Potential for improved performance of the district heating sector in Skopje will depend largely on the economic viability of the proposed CHP plan (discussed above). A viable CHP plant would allow lower cost supply heat supply as the plant would supply the district heating network with most of the costs of producing the heat paid by the electricity consumers.

Exergia also assessed the scope for district heating outside Skopje. Based on pre feasibility studies carried out for six cities in Macedonia, two of these – Bitola and Kocani - were identified as preferred candidates for district heating projects. Feasibility studies for two projects were carried out by Exergia. The studies suggested that positive economic returns would yield from investments of the order Euro 6 million in Bitola and Euro 6 million in Kocani. Noting that the small project sizes may be an obstacle to securing of finance, one option would be to roll district heating in to wider municipal investment programs; financing could then be sought on a consolidated basis (i.e. for the program as a whole rather than individual projects).

Natural Gas

Electricity is widely used for residential heating in Macedonia, particularly in urban areas, as shown in Table 2.4 below. Electric heating is both inefficient (as manifest in Macedonia's relatively high energy intensity, shown in Table 2.3 above) and undesirable from an environmental point of view in comparison to the use of gas for heating.

Though a gas pipeline was constructed in 1996 connecting Skopje to the Bulgarian gas network, and facilitating the import of Russian gas, capacity utilization is currently under 10 percent, and gas demand is only 1 percent of total energy demand in Macedonia.

Given the presence of the gas pipeline, and population density, Skopje is the most likely candidate for a Macedonia gasification project. The economics of gasifying areas in Skopje currently not served by the district heating network are dependent on the relative price of gas and power. A study carried out by COWI suggested that development of a Skopje gas distribution network would be economically viable at the then current gas and power prices.

In order for a Skopje gas distribution project to proceed, a number of issues would have to be settled (e.g. relating to ownership of the gas pipeline) and a framework for regulation of the gas industry developed.

In addition, a feasibility study would be required in order to elaborate details of a Skopje gasification project. It would build on the COWI study, providing precise estimates of costs and benefits associated with gasification, and through this, to specify a project design (in terms of areas to be covered, number of consumers to be connected, forecast prices, finance requirements, etc.). Such a feasibility study lies well beyond the realms of the current paper.

With progress in these areas, it may be feasible to structure a concession for development of a Skopje network; donor finance should be sought for development of such a concession. To the extent that market sentiment for gas distribution concessions is not favorable – the extent of private sector interest should become clear following tenders for gas distribution concessions underway or planned in a number of South East Europe (SEE) countries - construction of a gas distribution network could be financed on a sovereign basis.

In order for gasification to take place outside Skopje, a new north-south pipeline would be required. Such a pipeline would also potentially facilitate import of Caspian gas to Macedonia, possibly at a lower price than Russian gas. Recognizing the potential for import of Caspian gas through Turkey to SEE, a project to construct a new Greece – Turkey gas pipeline has been developed. In conjunction with the Greece-Turkey pipeline, Macedonia, Albania, Bosnia and Herzegovina, Greece, Serbia and Turkey signed an interconnection agreement in February 2003, whereby there was agreement to explore options for exporting gas from Turkey via Greece to the other signatory countries.

The World Bank has commissioned a preliminary study to establish possible delivery prices of Caspian gas to SEE countries. The study suggests that based on current off-take contract prices between Turkey and Azerbaijan, together with transport costs associated with new pipelines, Caspian gas would come in to Macedonia at a price slightly lower than the current Russian gas price. Delivered gas prices could fall if off-take prices in Turkey are renegotiated; there would seem to be scope for this given that off-take prices currently exceed costs of supply. Further work is required before any decisions to proceed with pipeline investment are made. To this end, the EC has launched a major study of gasification in SEE. This should be completed in 2005, and will help to establish whether a north – south gas pipeline in Macedonia is economically viable.

The Oil Industry

The petroleum sector in Macedonia consists of a refinery in Skopje (OKTA), a petroleum pipeline from the Greek border to the refinery, and a distribution system for petroleum products including terminals and service stations

The country's domestic demand for petroleum products is relatively stable at around 700,000-900,000 tons per year. The main products are gasoline (about 20 percent of consumption), diesel fuel (about 40 percent of consumption) and heavy fuel oil (about 30 percent of consumption). In addition there are miscellaneous products (LPG, jet fuel, lubricants) which account for the remaining (approximately) 10 percent of c