Europe and Central Asia Economic Update Office of the Regional Chief Economist April 2016 WORLD BANK ECA ECONOMIC UPDATE APRIL 2016 The Impact of China on Europe and Central Asia Office of the Chief Economist © 2016 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 19 18 17 16 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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ISBN (electronic): 978-1-4648-0912-5 DOI: 10.1596/978-1-4648-0912-5 Cover design: World Bank Contents Acknowledgments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Country groups. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii PART I: Economic Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 Policy Coordination Is Being Tested . . . . . . . . . . . . . . . . . . . . . . 3 Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.1  Hard times. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.2  A few silver linings in export and labor markets . . . . . . . . . . . . . . . . . . . . . . . . 6 1.3  The Refugee Crisis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 1.4  Fragility of banking sectors threatens economic recovery. . . . . . . . . . . . . . . . . 13 1.5  Policy makers are walking a tightrope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 2 China’s Impact on Europe and Central Asia. . . . . . . . . . . . . . . . . 27 Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 2.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 2.2  China: a dominant economic power in transition . . . . . . . . . . . . . . . . . . . . . . . 30 2.3  ECA’s links with China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 2.4  Gaining competitiveness vis-à-vis China. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 2.5  How does China’s growth slowdown affect ECA?. . . . . . . . . . . . . . . . . . . . . . . 47 2.6  Rebalancing: shifting opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 2.7 Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Annex A: Gravity Model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Annex B: Computable General Equilibrium Model. . . . . . . . . . . . . . . . . . . . . . . . . 62 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 PART II: Country Pages Albania. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Armenia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Azerbaijan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Belarus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Bosnia and Herzegovina. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Bulgaria. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Croatia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 iii iv  ●   World Bank ECA Economic Update April 2016 Georgia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 Kazakhstan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Kosovo. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Kyrgyz Republic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Macedonia FYR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Moldova. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 Montenegro. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Poland. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Romania. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 Russian Federation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 Serbia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 Slovenia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 Tajikistan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 Turkey. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Turkmenistan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 Ukraine. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 Uzbekistan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119 Boxes 2.1 Using a gravity model to explain trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 2.2 Computable general equilibrium model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Figures 1.1 Sharp declines in remittances in 2015 (percentage growth in 2015 of remittances, deflated by import price). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 1.2 Consumprion has sharply declined in Eastern Europe and Central Asia (annual growth rates 2015) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1.3 Global trade has settled on a slow growth path (annual growth, 12m/12m percentage). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 1.4 Euro area export growth now outpaces global average (percentage points difference between euro area export growth and global export growth, 12m/12m). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.5 European export growth accelerates as U.S. and Chinese exports slow down (2004–2015). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.6 Unemployment falling in the west and rising in the east . . . . . . . . . . . . . . . . . . 9 1.7 Strong growth of agriculture in the east. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1.8 Surge in monthly sea arrivals into Europe. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 1.9 Drop in capital flows not as large as it seems. . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1.10 Capital flows declined for Russia, and increased for Turkey. . . . . . . . . . . . . . . . 15 1.11 European banks remain fragile. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 1.12 Ruble exchange rate closely follows oil price. . . . . . . . . . . . . . . . . . . . . . . . . . . 21 1.13 Home prices recovering in most countries, but falling in oil-exporting countries (percentage change in home prices deflated by CPI 2015/2014). . . . . . . . . . . . 22 2.1 China’s domestic demand has been countercyclical to the global cycle . . . . . . 31 2.2 Slowdown in China coincides with decelerating potential growth. . . . . . . . . . . 32 2.3 China is catching up to the European Union. . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 2.4 Since 2000 education levels in China are sharply increasing . . . . . . . . . . . . . . . 34 Contents ●  v 2.5 ECA has become more open to trade and is more open than other regions. . . 35 2.6 China’s share of imports by ECA has expanded rapidly, 1996–2014 (share of imports from China in total imports, percent). . . . . . . . . . . . . . . . . . . . 36 2.7 China’s share of ECA’s exports is less than its share of imports, 1996–2014 (share of exports to China in total exports, percent). . . . . . . . . . . . . . . . . . . . . . 37 2.8 ECA’s exports to China are mostly manufactures (percent of total exports). . . . 37 2.9 Germany’s and Kazakhstan’s trade with China increased sharply, 2000–14 (constant prices). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 2.10 More rapid growth of exports to China than to Russia reflected China’s booming per capita income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 2.11 Kazakhstan has greater potential than Germany to increase exports to China (exports to China at constant prices). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 2.12 Eastern ECA may have greater potential than western ECA to increase exports to China (exports to China by sector from ECA sub-regions). . . . . . . . 42 2.13 China’s potential to increase import penetration in ECA is limited (imports from China by sector from ECA sub-regions). . . . . . . . . . . . . . . . . . . . 43 2.14 ECA currencies depreciated sharply over past year (percent change in real exchange rate with China, Jan–Feb 2015 to Jan–Feb 2016) . . . . . . . . . . . . . . . 45 2.15 Exchange rate depreciation could boost ECA’s exports to China (percent change in volume of total exports). . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 2.16 Exchange rate depreciation has created opportunities to compete with imports (percent change in potential imports as a result of real exchange rate depreciation in ECA). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 2.17 China imports primary goods and exports manufactures (net surplus as a percent of world trade, 2016 Business as Usual). . . . . . . . . . . . . . . . . . . . . 49 2.18 China’s slowdown has a mixed impact on ECA’s exports (percentage difference in export values in slowdown compared to business as usual scenario) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 2.19 Share of exports in GDP is larger in the east (forecast of 2016 export to GDP ratio at current prices, percent). . . . . . . . . . . . . . . . . . . . . . . . . . 51 2.20 China’s slowdown improves returns to workers, particularly unskilled workers (percent change in China slowdown versus business as usual scenarios). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 2.21 Lower investment would particularly affect China’s demand for high-skilled manufactures (expenditures as a share of final demand, 2015) . . . . . . . . . . . . . 54 2.22 Skilled workers in total employment, in China (percent). . . . . . . . . . . . . . . . . . . 54 2.23 Change in private consumption relative to business as usual scenario (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 2.24 Rebalancing boosts China’s exports of high-skilled manufactures and reduces ECA’s (percentage dierence between rebalancing and business as usual scenarios). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 2.25 China rebalancing reduces the skill premium globally (percentage difference in skill premium between rebalancing and business as usual scenarios). . . . . . . 57 2.26 China skilling reduces the return on urban occupations for unskilled workers (percentage difference between wages of unskilled in urban versus rural occupations in rebalancing versus business as usual scenarios). . . . . . . . . 57 vi  ●   World Bank ECA Economic Update April 2016 Tables 0.1 Regional classification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi 1.1 Weak growth in Europe and Central Asia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.2 Banking problems in Eastern Europe and Central Asia. . . . . . . . . . . . . . . . . . 16 1.3 Large differences in 2015 between GDP and CPI deflators . . . . . . . . . . . . . . 20 1.4 Increased debt ratios restrict fiscal space for most countries in the region . . 23 A1 Gravity Model Results. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 A2 Sectoral classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 B1 Global market share by importer and good (%). . . . . . . . . . . . . . . . . . . . . . . 62 B2 Global Market share by exporter and good (%) . . . . . . . . . . . . . . . . . . . . . . . 62 B3 Chinese imports by source and good (%). . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 B4 Chinese exports by destination and good (%) . . . . . . . . . . . . . . . . . . . . . . . . 63 B5 Imports from China as a percent share of imports from all countries. . . . . . . 64 B6 Exports to China as a percent share of exports to all countries . . . . . . . . . . . 64 B7 Trade surplus (+) or deficit (-) as % of world trade. . . . . . . . . . . . . . . . . . . . . . 65 B8 Trade flows in current prices, % difference China slowdown versus BaU, total trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 B9 Trade flows in current prices, % difference China slowdown versus BaU, high-skill manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 B10 Regional aggregation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 B11 Sectoral aggregation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Acknowledgments The Europe and Central Asia (ECA) Economic Update is a joint product of ECA’s Office of the Chief Economist, the Macro and Fiscal Management Global Practice, and the Poverty Global Practice, with inputs from the Developments Prospects Group. Part I was prepared by a team in the Chief Economist Office, led by Hans Timmer, and including Maurizio Bussolo, David Michael Gould, Raquel Alejandra Letelier, Tu Chi Nguyen, Georgi Panterov, William Shaw and Ekaterina Ushakova. Chapter 1 benefitted from forecasts prepared by economists in the Macro and Fiscal Management Global Practice, which are presented in Part II. Valuable comments for Part I were provided by Aurora Ferrari, Birgit Hansl, Bert Hofman, Leszek Pawel Kasek, Christos Kostopoulos, Alexander Pankov, Sudhir Shetty, Nikola Spatafora and Sergey Ulatov. Part II with the country pages was prepared by teams in the Macro and Fiscal Management Global Practice (led by Andrew Burns, Ivailo Izvorski, and Miria Pigato) and in the Poverty Global Practice (led by Carolina Sanchez). These teams included the following staff: Enrique Aldaz-Carroll, Sarah Nankya Babirye, Marina Bakanova, Ulrich Bartsch, Thi Thanh Thanh Bui, Cesar Cancho, Raul Andres Castaneda, Marie-Anne Chambonnier, Alexandru Cojocaru, Marcel Chistruga, Pablo Facundo Cuevas, Barbara Cunha, Maria Eugenia Davalos, Nancy Sabina Davies-Cole, Agim Demukaj, Doerte Doemeland, Mariam Dolidze, Bakyt Dubashov, Olga Emelyanova, Mismake D. Galatis, Anastasia Golovach, Gohar Gyulumyan, Kiryl Haiduk, Birgit Hansl, Fayavar Hayati, Sandra Hlivnjak, Stella Ilieva, Maria Gabriela Inchauste Comboni, Charl Jooste, Kamer Karakurum- Ozdemir, Naoko Kojo, Christos Kostopoulos, Aurelien Kruse, Leszek Pawel Kasek, Sanja Madzarevic-Sujster, Dorsati Madani, Mikhail Matytsin, Kristina Cathrine Mercado, Moritz Meyer, Jose Montes, Minh Cong Nguyen, Trang Van Nguyen, Olasupo Olusi, Catalin Pauna, Ruslan Piontkivsky, Juan Pradelli, Mona Prasad, Alisher Rajabov, Nadir Ramazanov, Ilyas Sarsenov, Lazar Sestovic, Rashmi Shankar, Hilda Shijaku, Bojan Shimbov, Maryna Sidarenka, Kenneth Simler, Nistha Sinha, Emily Sinnott, Emilia Skrok, David Andrew Stephan, Congyan Tan, Wenxia Tang, Ashley Taylor, Eskender Trushin, Sergey Ulatov, Ekaterina Vostroknutova, Judy Yang, Ayberk Yilmaz. Ekaterina Ushakova oversaw the layout and production of the report. Michael Alwan edited and typeset the report. Artem Kolesnikov worked on the cover design. Paul Clare, Dmitro Derkatch, Elena Karaban and John Mackedon provided communications and outreach support, including the dedicated webpage (http://www.worldbank.org/en/region/eca/publication/ europe-and-central-asia-economic-update-april-2016). vii Abbreviations AMC Asset management companies BaU Business as usual BH Bosnia and Herzegovina BIS Bank for International Settlements BRICS Brazil, Russia, India, China and South Africa CDS Credit default swaps CGE Computable general equilibrium CIS Commonwealth of Independent States CIT Corporate Income Tax CPI Consumer price index ECA Europe and Central Asia ECB European Central Bank ECE Early Care and Education EDP Excessive Deficit Procedure EEU Eurasian Economic Union EFTA European Free Trade Association EMU Economic and Monetary Union FDI Foreign direct investment FYR Former Yugoslav Republic GEM Global Economic Monitor GDP Gross domestic product GTAP Global Trade Analysis Project HPP Hydro power projects IMF International Monetary Fund ISIC International Standard Industrial Classification LIBOR London Interbank Offered Rate LTE Long-Term Evolution MTO Medium-Term Objective NPL Non-performing loans OPEC Organization of the Petroleum Exporting Countries PPML Poisson Pseudo-Maximum Likelihood PPP Purchasing power parity S&P Standard & Poors SAA Stabilization and Association Agreement SOE State-owned enterprises US United States WEO World Economic Outlook WDI World Development Institute ix Country groups TABLE 0.1 Regional classification Western Southern Central Northern Western Europe Europe Europe Europe Balkans Austria Greece Bulgaria Denmark Albania European Belgium Italy Croatia Finland Bosnia and Union France Portugal Czech Republic Sweden Herzegovina and Kosovo Germany Spain Hungary Estonia Western FYR Macedonia Balkans Ireland Cyprus Poland Latvia Luxemburg Malta Romania Lithuania Montenegro Europe Serbia The Netherlands Slovak Republic and Central United Kingdom Slovenia Asia South Central Russian Other Eastern Caucasus Asia Federation Turkey Europe Eastern Europe Armenia Kazakhstan Belarus and Azerbaijan Kyrgyz Republic Moldova Central Georgia Tajikistan Ukraine Asia Turkmenistan Uzbekistan xi Introduction The economies of Europe and Central Asia (ECA) are facing complex headwinds. The policy reaction to those headwinds may change these economies for years to come. Against the backdrop of adverse global developments, the prospects for many ECA economies are for weak growth, at best. However, several of the headwinds also carry seeds for future growth. The collapse in oil revenues and remit- tances, and the associated sharp real depreciations, improve competitiveness in the production of internationally tradable products (this was also analyzed in detail in the September 2015 edition of the ECA economic update1). The weakening of the Euro, caused by monetary policies of the Federal Reserve and The European Central Bank moving in opposite directions, makes European countries more competitive, as is already demonstrated in recent export data. The current slowdown and trans- formation of China’s economy can make producers in ECA more competitive, even if the changes in China might also have negative welfare impacts for some parts of the region.  In the eastern part of ECA, the task of governments is to orchestrate a coordinated crisis response. The collapse of oil revenues and the associated decline in remittances has triggered a chain reaction of shocks. Adjustment to these shocks requires a new monetary policy regime, resolution of serious fragilities in banking sectors, fiscal reforms that put government finances on a sustainable path, while guaranteeing fair burden sharing, and facilitation of job creation in sectors that compete internation- ally. It is crucial that, while a deepening of the crisis is being avoided, policies resolutely enable the necessary shift away from the production of non-tradables to the production of tradables. Improve- ment of institutions and governance is needed to eliminate binding constraints that deter the devel- opment of new activities. In the western part of ECA, policy coordination within the European Union is being tested by the refugee crisis and a possible Brexit. At the same time, the modest recovery continues in this part of the region. To put this recovery on a sustainable path it is crucial that the European Union can address changes in the economic environment, like the individualization of labor markets in the sharing economy, in an effective and coordinated way. Meanwhile, the Chinese economy has slowed down and is in the process of a fundamental trans- formation. The economy is shifting from investments to consumption, from inward FDI to outward FDI, and from low-skill intensive to skill-intensive production. These developments are having major impacts on the ECA region. The changes in China’s economy can have adverse impacts on exporters of investment goods and natural resources. It can mean a competitive challenge for countries with a comparative advantage in skill-intensive production. However, it creates opportunities for those who compete at the lower end of manufacturing and for those who receive China’s outward FDI. This report analyses all of these challenges and points outs the opportunities to become more com- petitive in global markets. These opportunities are strongly supported by the real depreciation that many countries in the region have undergone.  Note 1. http://www.worldbank.org/en/region/eca/publication/europe-and-central-asia-economic-update- october-2015 xiii PART I Economic Outlook 1 Policy Coordination Is Being Tested Summary • The European Union continues its modest recovery, benefitting from acceler- ating exports, driven by real deprecation of the euro. Despite daunting politi- cal challenges in the European Union, there are silver linings on the economic horizon, illustrated by a one percentage point reduction in the unemployment rate in 2015. • Growth in the European Union and the Western Balkans is expected to stabi- lize at 1.8 percent. Growth is especially robust in Central Europe and the West- ern Balkans. In both sub-regions GDP growth is expected to exceed 3 percent next year. • The economies of Europe and Central Asia (ECA) are facing complex chal- lenges. The task of governments is to orchestrate a coordinated crisis response to the collapse in oil revenues and the subsequent shocks: declines in remit- tances, depreciations, fall in real-estate prices, increased NPLs, and solvency problems in the banking sectors. • Following double-digit terms-of-trade losses, in addition to a GDP contraction of 1.1 percent in 2015, GDP in Eastern Europe and Central Asia is expected to show practically no growth in 2016, implying a downward adjustment of one percentage point since late last year. Especially large are the downward ad- justments for the South Caucasus (3.3 percentage points), Central Asia (1.6 percentage points) and Russia (1.3 percentage points). 3 4  ●   World Bank ECA Economic Update April 2016 1.1 Hard times The global economic environment has become more challenging for economies in Europe and Central Asia. Global trade is growing at a historically slow pace, partly because of disappointing growth in emerging economies. International capital flows are subdued, as investors are looking for safe havens. Low and vola- tile oil prices, together with geopolitical tensions, remain a huge challenge for economies in the eastern part of the region. The refugee crisis is threatening a turn towards inward-looking policies in European countries, jeopardizing free cross-border movements in the Schengen area. The Brexit referendum further tests European cooperation and integration. Terrorist attacks in France, Turkey, and Belgium have heightened anxiety throughout the region. Despite many common threats, prospects differ substantially across the re- gion. Oil-exporting countries and countries that depend on remittances from those oil-exporting countries are in recession or close to recession (see table 1.1). After a contraction of 1.1 percent in 2015 in Eastern Europe and Central Asia, GDP in this sub-region is now expected to show practically no growth in 2016, implying a downward adjustment of a full percentage point since the last re- gional forecast in October 2015. Especially large are the downward adjustments for the South Caucuses (3.3 percentage points), Central Asia (1.6 percentage points), and Russia (1.3 percentage points). In the European Union and the West- ern Balkans, on the other hand, GDP growth is expected to average 1.8 percent this year, unchanged from the expectations half a year ago. In Southern Europe the recovery is finally taking hold, although growth is still not strong enough to undo the damage caused by the Great Recession. GDP in Southern Europe is still 4 percent below its 2007 level, while GDP in other parts of the European Union has well sur- passed pre-crisis levels. Growth is forecast to remain robust in Central Europe. TABLE 1.1  Weak growth in Europe and Central Asia Change in forecast since GDP growth, % annual October 2015 2014 2015e 2016f 2017f 2015e 2016f Europe and Central Asia 1.2 1.4 1.6 1.9 0.0 −0.3 European Union and Western Balkans 1.3 1.9 1.8 1.8 0.0 −0.1 Western EU 1.5 1.7 1.7 1.7 −0.1 −0.2 Northern EU 1.5 2.2 2.3 2.2 0.2 0.0 Central EU 2.8 3.5 3.2 3.1 0.2 0.0 Southern EU 0.3 1.6 1.6 1.6 0.2 0.1 Western Balkans 0.5 2.2 2.7 3.2 0.5 0.4 Eastern Europe and Central Asia 0.2 −1.1 0.1 2.0 0.4 −1.0 South Caucasus 3.2 1.6 −0.6 1.7 −0.4 −3.3 Central Asia 5.0 2.7 1.9 3.2 0.0 −1.6 Russian Federation −1.4 −3.7 −1.9 1.1 0.1 −1.3 Turkey 2.9 4.2 3.5 3.5 1.0 0.1 Other Eastern Europe −4.0 −7.8 −0.2 1.2 1.3 −0.7 Source: World Bank data Chapter 1: Policy Coordination Is Being Tested ●  5 The eastern part of the region is hit by a pervasive crisis, as the collapse of oil prices caused a chain reaction with far-reaching consequences. Steep de- clines in oil revenues and sharply reduced purchasing power of remittances have led to double digit declines in real income, much larger than declines in GDP or other measures of production volumes. Figure 1.1 illustrates the decline in remit- tances, deflated by the import price, in some remittance-dependent countries in Eastern Europe and Central Asia in 2015. These declines range from 25 to 35 percent. The drop in income in oil-exporting and surrounding economies make major reductions in imports unavoidable, and will require increases in exports to keep the external balance of payments sustainable and to create employment in tradable sectors as jobs in the non-tradable sectors are being lost. Currency depre- ciations are needed to trigger these adjustments. However, these depreciations expose fragilities in banking sectors across this part of the region because of large financial dollarization. Banks are further tested as NPLs are on the rise, the profit- ability of domestic sales is waning and real estate prices start falling. The magnitude of the impact of lower oil prices on oil-exporting countries was already apparent in 2015. Figure 1.1 illustrates the decline in remittances, deflated by the import price, in 2015. These declines range from 25 to 35 percent. The impact of lower oil revenues on domestic consumption and imports is espe- cially clear. For example, in Russia GDP contracted 3.7 percent in 2015, while pri- vate consumption declined 10 percent and import volumes fell by almost 30 per- cent. These numbers reflect the large terms-of-trade losses and the sharp depreciation that were caused by the collapse of oil prices. For the whole of East- ern Europe and Central Asia growth in private consumption is expected to resume only in 2017, and there are significant downside risks to that forecast (see figure 1.2). Countries in the European Union face multiple risks. The refugee crisis puts to the test Europe’s ability to effectively coordinate policies. The possibility of the United Kingdom exiting the European Union (BREXIT) is yet another example of the political complications in the European integration process. This elevated uncertainty has sup- pressed stock markets and sustained fragility in banking sectors. Employment has still not fully recovered from the Great Recession, while structural shift towards more flexible work arrangements requires a rethinking of the social contract. FIGURE 1.1 Sharp declines Country in remittances in 2015 Belarus Armenia Ukraine Moldova Kyrgyzstan Georgia 0 (percentage growth in 2015 of remittances, deflated by 5 import price) 10 Percentage growth 15 20 25 30 35 40 Source: National Central Banks 6  ●   World Bank ECA Economic Update April 2016 FIGURE 1.2 Consumption has sharply declined in Eastern Europe and Central Asia (annual growth rates 2015) 10 5 0 e va s ia ia an n an ey an n lic ru in ija rg en Annual growth (%) tio do st rk ist ra st la ub ba eo m ki kh Tu ra Be Uk ol jik p be Ar er G de M Re 5 za Ta Az Uz Fe Ka yz n rg ia Ky ss Ru 10 15 Country 20 25 GDP growth (%) Private consumption growth (%) Source: World Bank data, staff calculations Still, the economic prospects in the European Union also contain silver lin- ings. The weaker euro, caused by monetary policy adjustments in the Federal Reserve and the ECB, and low oil prices help sustain the cautious recovery. This is particularly apparent in export volumes that outpace global trade. The European Union will likely experience in 2017 its fifth year in a row of positive GDP growth. The longer the recovery continues, the more outcomes can surprise on the upside. But for the moment the strength of the recovery remains disappointing. While the European Union is focused on sustaining and strengthening the recovery, many countries in Eastern Europe and Central Asia are trying to pre- vent a worsening of the economy. The key problem in the European Union is that policy options are limited. Monetary easing is approaching its limits as inter- est rates have entered negative territory. And, although slowly more fiscal space is being created, government debt remains at high levels. The key problem in Eastern Europe is that the dramatically changed economic environment requires fundamental changes in both monetary and fiscal policy, while there is little to no time for trial and error. The remainder of this chapter consists of four sections. The first one de- scribes recent trends in trade and labor markets. The next one analyzes interna- tional capital flows and financial markets. That section is followed by an inter- mezzo that describes recent developments in the refugee crisis. The chapter concludes with a discussion of monetary and fiscal policy options. 1.2 A few silver linings in export and labor markets The volume of global trade expanded in 2015 at a rate of 2 percent. That is 3 percentage points lower than the average growth rate over the last 25 years. This partly mirrors a weakening of the global economy, but mostly reflects a structural Chapter 1: Policy Coordination Is Being Tested ●  7 change. The volume of global trade used to grow roughly twice as fast as the volume of global industrial production, but now both are growing more or less at the same rate. Global industrial production grew 1.9 percent in 2015, merely 0.8 percentage points below its long-term average (figure 1.3). Many factors may explain the structural slowdown in global trade. Chief drivers of the lower production elasticity of trade are a slower pace of expansion of global supply chains and lower investment rates, as investment is more im- port-intensive than other components of global GDP1. Other possible explana- tions for the structural decline of global trade growth are the slower pace of trade liberalization and slower declines in transportation costs. However, even with lower overall trade growth there are still opportunities to gain market share. This was recently illustrated by Europe’s export perfor- mance. For a long period export growth of the Euro Area had fallen behind global export growth. During the last ten years export growth from the Euro Area aver- aged 1.2 percent per year, less than half the 2.9 percent global annual growth during that same period. In 2015, however, the Euro Area’s export growth exceeded the global average (figure 1.4). This follows the divergence of monetary policy between the Federal Reserve and the ECB, which resulted in a real depreciation of the euro. The impact of real effective exchange rates on trade is clearly illustrated in figure 1.5. It plots the deceleration of export volume growth in 2015 against the real effective depreciation. China and the United States experienced double digit real effective appreciations and, as a result, their export growth decelerated by between 4 and 5 percentage points. All European countries, on the other hand, experienced a real effective depreciation and almost all saw faster growth of ex- ports than in 2014. The more dramatic depreciations in Eastern Europe and Central Asia pro- vide an even greater potential for more rapid export growth than in the Euro FIGURE 1.3 Global trade has settled on a slow growth path (annual growth, 12m/12m percentage) 15 10 5 Annual growth (%) 0 12 12 12 12 12 12 12 12 12 12 12 12 m m m m m m m m m m 4m m 00 06 02 08 04 10 12 96 92 98 94 1 20 20 20 20 20 20 20 20 19 19 19 19 5 Year 10 15 Global trade Global industrial production Source: Netherlands Bureau of Economic Analysis (http://cpb.nl/cijfer/cpb-wereldhandelsmonitor-januari-2016) 8  ●   World Bank ECA Economic Update April 2016 FIGURE 1.4 Euro area export growth now outpaces global average (percentage points di erence between euro area export growth and global export growth, 12m/12m) 2 Year 1 12 12 12 12 6m 9m m 3m 12 0 0 0 20 20 20 20 0 12 Growth di erence (%) m 15 –1 20 –2 –3 –4 –5 6 Source: Netherlands Bureau of Economic Analysis (http://cpb.nl/cijfer/cpb-wereldhandelsmonitor-januari-2016) FIGURE 1.5 European export 15 growth accelerates as U.S. and Chinese exports usa slow down (2014–2015) chn Change of real e ective exchange rate (%) 10 5 0 –6 –5 –4 –3 –2 –1 0 1 2 3 4 cze pol nld hun slk fin dnk –5 esp ita deu swe –10 –15 Change of export volume growth (%) Source: World Bank GEM data Area. Chapter 2 of this publication presents model simulations of the potential impact of those depreciations. The extent to which this potential is realized de- pends on how easily jobs in the tradable sectors can be created to replace the jobs that are currently being lost in the non-tradable sectors. The long period of high and rising oil prices has wiped out many firms that were no longer internation- ally competitive and has rewarded rent seeking rather than efficiency in non- tradable sectors like construction. This, combined with the considerable chal- lenges in banking sectors, complicates the necessary transition. Chapter 1: Policy Coordination Is Being Tested ●  9 Recent developments in labor markets confirm the brighter prospects in the western part of the region and the serious challenges in the eastern part. The unemployment rate in the European Union fell to 9 percent in December 2015, down almost 1 percentage point from a year before. This is equivalent to about 2 million individuals exiting unemployment. Labor market conditions especially improved in Central Europe, with unemployment rates falling in 2015 by close to 2 percentage points in Croatia, Macedonia, and Poland (figure 1.6A). The falling unemployment rate in the European Union coincides with moderately decreasing real unit labor costs, which echo the improved international competitiveness dis- cussed above. The employment rate is back to its pre-crisis level, just above 70 FIGURE 1.6 Unemployment falling in the west and rising in the east a. Central Europe Country YR lic lic ub ,F ub p ia p Re Re on a ia ia ry ia ni a tia an d en ed ak ga ar h ni ua a an ec oa vi lg m to ov ov ac un th l t Bu Cz Ro Po Es La Cr M Sl Sl Li H 0.0 -0.5 Percentage points 1.0 1.5 2.0 2.5 Change 2014–2015 Change 2015–2016 b. Eastern Europe and Central Asia 1.0 0.8 Percentage points 0.6 0.4 0.2 0.0 Kazakhstan Ukraine Turkey Russian Belarus Moldova 0.2 Federation Country Change 2014–2015 Change 2015–2016 Source: World Bank data, staff calculations 10  ●   World Bank ECA Economic Update April 2016 percent. However, the unemployment rate is still much above its pre-crisis level of 6.8 percent. The higher unemployment rate and equal employment rate (com- pared to pre-crisis levels) reflects long-term trends of increasing participation rates of women and older workers. Labor markets are deteriorating in the east as jobs in the non-tradable sec- tors are being lost. In many countries of Eastern Europe and Central Asia unem- ployment increased in 2015 (figure 1.6B). Jobs are being lost in sectors that pro- duce for the domestic markets, like construction and retail services. Job creation in sectors that compete internationally has not yet been enough to compensate for these losses. In several of these countries unemployment rates may rise further due to the return of migrants from Russia – a migrant destination for many work- ers in the region. Given that labor income (from domestic or foreign sources) has been a major driver of poverty reduction and shared prosperity in the past, the job losses and declines in purchasing power of remittances are likely to reverse those positive trends. The only viable and sustainable response to lower oil revenues and lower remittances is a shift of employment opportunities towards tradable sectors. Such a shift takes time, but there are already first signs of changes in this direc- tion. In most countries in the East, with the exception of Moldova which experi- enced a drought, agriculture made a greater contribution to output growth in 2015 than in past years. Real depreciation has made it easier for farmers to com- pete with foreign competitors. The growth of the agricultural sector also helped compensate for the slower growth, or contraction, of the industrial sector in Azer- baijan, the Kyrgyz Republic and Russia (figure 1.7). Going forward, economies can sufficiently stem the tide of job losses only by seizing opportunities in manu- facturing and services sectors that compete with foreign producers. FIGURE 1.7 Strong growth of agriculture in the east 15 10 Percentage change in 2015 5 0 Ukraine Belarus Russian Moldova Kazakhstan Azerbaijan Georgia Kyrgyz Armenia Turkey Tajikistan Uzbekistan Federation Republic 5 Country 10 15 Agriculture Industry Services GDP Source: World Bank data, staff calculations Chapter 1: Policy Coordination Is Being Tested ●  11 The sheer magnitude of the oil price collapse and the pervasiveness of its con- sequences imply that substantial downside risks surround the macroeconomic and poverty forecasts for the Eastern Europe and Central Asia. Only coordinated and swift policy response can prevent a deepening and broadening of the adverse impacts. The required policy responses range from adjusting monetary policy to stabilizing banking sectors, and putting fiscal accounts back on a sustainable path. But none of the policy responses will be successful in the long run if institutional or other impediments prevent further diversification in product and job markets. 1.3 The Refugee Crisis Due to the conflicts in Syria, Iraq, and continuing violence and instability in Afghanistan, as well as other conflicts in the Middle East and Africa, a bur- geoning refugee and humanitarian crisis has exploded onto the global stage. As of March 2016 approximately 4.8 million Syrian refugees were registered in Turkey, and the Middle East and North Africa region. Of these refugees, 2.7 mil- lion were registered in Turkey, 1 million in Lebanon, 635,000 in Jordan, 245,000 in Iraq and 145,000 in Egypt and other North African countries. Of the nearly 5 mil- lion refugees, 220,000 were registered in the first 3 months of 2016.2 About a quarter of these people, some 1.2 million, have made the risky and arduous jour- ney from the Middle East and North Africa by sea to Europe, landing mostly in Italy and Greece (figure 1.8). Three nationalities accounted for 85 percent of the total arrivals from January 2015 to March 2016: Syria—46 percent, Afghani- stan—24 percent, and Iraq—15 percent. The remainder came mainly from Iran, Pakistan, and various conflict afflicted countries in Africa. First-time asylum ap- plications in Europe by people from Syria, Afghanistan and Iraq jumped some 130 percent in the 12 months between Q4 2014 and Q4 2015.3 Many European countries are concerned about the economic and social impact of these flows. FIGURE 1.8 Surge in monthly sea arrivals into Europe 250,000 200,000 Number of sea arrivals 150,000 Partial month data 100,000 as of March 22 50,000 0 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Month Source: http://data.unhcr.org/mediterranean/regional.php 12  ●   World Bank ECA Economic Update April 2016 Unlike a gradual flow of economic migrants, refugees typically arrive over a relatively short period of time and are often concentrated in a small number of local communities. The sudden and concentrated arrival creates more compli- cations for the host countries than the sheer size of the refugee flows. For the EU as a whole, the 1.2 million sea arrivals from all refugee countries represents only about 0.2 percent of the total population in 2015 (about half that for just Syrian refugees). By comparison, prior to the current refugee crisis (on January 1, 2014), 33.5 million people (6.4 percent of the total population) living in the EU28 had been born outside the EU28. However, for some host communities the change has been dramatic. In addition, the relatively modest increase in the number of peo- ple (as a share of the total population) who are coming in as refugees comes on top of a relatively large within-EU28 migration experienced since 2000 due to greater regional integration (on average the total foreign-born population within EU28 countries, including from other EU28 countries, is nearly 10 percent). The crisis primarily is driven by the rapid increase in the number of refu- gees and lack of capacity to manage these inflows of people and allocate them among EU countries. In September, 2015 an agreement was reached among EU member states to reallocate some 120,000 refugees from Italy, Greece and Hun- gary.4 As of March 2016, some 5,500 have been relocated or resettled.5 Subse- quently, an agreement was reached between Turkey and the EU to manage the flow of Syrian migrants into Europe.6 The EU and Turkey agreed to: • return to Turkey all irregular migrants crossing from Turkey to the Greek is- lands from 20 March 2016, in full accordance with EU and international law • for every Syrian returned to Turkey (up to 72,000 Syrian refugees in 2016), another Syrian will be resettled from Turkey to the EU, on the basis of existing commitments • Turkey will take any necessary measures to prevent new sea or land routes for illegal migration • once irregular crossings end, a voluntary humanitarian admission scheme will be activated and the EU will further speed up the disbursement of the initially allocated €3bn support to Turkey and will mobilize an additional €3bn once these resources are used and provided commitments have been met • the EU and Turkey will work to improve humanitarian conditions inside Syria • EU leaders and Turkey also agreed to accelerate the fulfilment of the visa liber- alization roadmap, with a view to lifting visa requirements for Turkish citizens by end of June 2016 at the latest, if all benchmarks have been met. They recon- firmed their commitment to re-energize the accession process as set out in the joint statement of 29 November 2015. They agreed, as a next step, to open chap- ter 33 on financial and budgetary provisions in Turkey’s accession negotiations. The success of any program will depend on the ability of migrants and refu- gees to successfully integrate into the economic and social fabric of the host countries. It is unlikely that many Syrian refugees will return to the worst af- fected areas in the near future, as a return to stability and economic reconstruc- tion will likely take years. Institutions will need to be enhanced to improve host countries’ ability to absorb migrants, as will education, housing, and programs to facilitate integration. Yet, while there are modest adjustment costs, migration offers Chapter 1: Policy Coordination Is Being Tested ●  13 far greater dynamic growth benefits through increasing the working age popula- tion and adding to the labor and human capital endowment of the receiving country.7 These critical factors are not directly addressed in recent proposals, but are on the minds and agendas of many host country residents and policy makers. 1.4 Fragility of banking sectors threatens economic recovery Economic developments in Europe and Central Asia are evolving against the backdrop of heightened anxiety in international financial markets. These fi- nancial concerns have led to elevated spreads, especially for exporters of natural resources, and have slowed international capital flows to emerging markets as investors are looking for safe havens. First indications are that the dollar value of portfolio flows and bank lending to emerging markets in 2016 will fall signifi- cantly below 2015 levels, and that capital flows to emerging markets in Europe and Central Asia will be especially small (figure 1.9A). FIGURE 1.9 Drop in capital flows not as large as it seems a. Gross Capital Flows Index (nominal US$, 2010=100) 200 180 160 Nominal US$ 140 120 100 80 60 40 20 0 2010 2011 2012 2013 2014 2015 Year EAP ECA b. Gross Capital Flows Index (% of GDP, 2010=100) 140 120 Percent of GDP 100 80 60 40 20 0 2010 2011 2012 2013 2014 2015 Year EAP ECA Source: World Bank data, staff calculations 14  ●   World Bank ECA Economic Update April 2016 The drop in capital flows is less severe if expressed as percent of GDP in receiving countries. The decline in the dollar value of capital flows has been re- inforced by the appreciation of the dollar. By definition the dollar value of GDP declined in countries that underwent large real depreciations vis-à-vis the dollar. Many of those countries are in Eastern Europe and Central Asia. As a result, the relative size of the capital inflows did not decline as much as the nominal dollar values suggest. Figure 1.9B provides a striking example. In recent years capital flows into emerging Europe and Central Asia have substantially fallen behind capital flows into emerging East Asia. This largely reflects the difference in real depreciation; as a percent of nominal GDP the difference in capital flows was much smaller. However, it remains that globally capital flows are likely to fall sharply in 2016. The reduction in capital flows is not uniform across the region (figure 1.10). The gradual decline in lending to Russia from international banks and bond mar- kets coincided with a sharp rise of these capital flows to Turkey. Capital flows into Russia have been limited by international sanctions, but the decline in flows to Russia very much resembles that of other oil exporting countries. This implies that the problems banking sectors in oil-exporting countries face as a result of reduced oil revenues and associated depreciations have been exacerbated by in- ternational capital reversals. The decline in oil prices and subsequent currency devaluations have had major effects on the financial sectors in oil producing countries. • In Russia, the significant devaluation of the ruble has increased the cost of foreign debt service for the banking sector and increased the risk of default on foreign currency denominated loans issued by banks, leading to capital short- falls. The authorities pledged approximately one trillion rubles (US$16.5 bil- lion) in December 2014 to recapitalize systemic banks. The majority of these funds have now been utilized, and it is possible that further state support will be necessary as NPLs continue to rise. • In Azerbaijan, expected devaluations caused a doubling of the share of dollar deposits during 2015, significantly widening the currency mismatch of banks, leading them to recognize massive conversion losses which eroded their capi- tal. In addition, the sharp reduction of export proceeds from oil and lower domestic demand has boosted NPLs, bringing additional losses and capital erosion to the banking sector. • In Kazakhstan, tight monetary policy to prevent further devaluation of the tenge has led to a squeeze in local currency liquidity and a rise in interest rates. Lending and profitability are likely to be weak in 2016–17, and asset quality is likely to deteriorate. Credit demand is also likely to be low, as the weak eco- nomic outlook will encourage households and businesses to deleverage. Financial sectors of countries closely integrated with Russia have also been hit. The depreciation of the ruble sharply reduced the purchasing power of remit- tances, which in turn triggered depreciations in remittances-receiving countries with adverse impacts on their financial sectors. Moreover, companies in sur- rounding countries saw their competitiveness vis-à-vis Russian producers erode, which impaired profitability in banking sectors. Finally, a decline in banking sec- Chapter 1: Policy Coordination Is Being Tested ●  15 tor flows from Russia is also likely to affect banking sectors in neighboring coun- tries, given the non-negligible presence of Russian banks in some of them. The oil shock with all its repercussions has afflicted financial sectors that already had poor governance. Insufficient powers and low capacity of supervi- sors, inadequate financial safety nets, limited depth and underdeveloped finan- cial infrastructure have made the banking sectors in Eastern Europe and Central Asia very vulnerable to adverse shocks. State ownership of banking assets remains high in several countries in the region, leading in some cases to political interven- tion, regulatory forbearance, and interconnected institutions, resulting in large sec- toral and related-party lending, diminishing the efficiency and sustainability of the business model, and making it more difficult to adjust to external shocks. Under these circumstances, the first priority is prevention of an escalating banking crisis. Given that several countries are facing banking sector distress or are already in a full-fledged banking crisis, a clear and comprehensive crisis re- sponse framework needs to be put in place, including emergency liquidity sup- port to prevent contagion, least-cost resolution of failed banks, state intervention and support of systemic banks, and adequate funding of deposit insurance schemes. An assessment of the major threat that banking sectors face (see, for example, table 1.2) is indispensable for an effective crisis response. Apart from an urgent crisis response, banking sectors in Eastern ECA are in urgent need of reform. While during the oil boom banking sectors could survive FIGURE 1.10 Capital flows a. Average Annual Bonds Issuance by Region (% of GDP) declined for Russia, and 5 increased for Turkey 4.5 4 % of GDP 3.5 3 2.5 2 1.5 1 0.5 0 2010 2011 2012 2013 2014 2015 Year Russia Turkey b. Average Annual Bank Lending Flows by Region (% of GDP) 5 4.5 4 3.5 % of GDP 3 2.5 2 1.5 1 0.5 0 2010 2011 2012 2013 2014 2015 Year Russia Turkey Source: World Bank data, staff calculations 16  ●   World Bank ECA Economic Update April 2016 TABLE 1.2  Banking problems in Eastern Europe and Central Asia Remittances Currency Open foreign Capital Liquid assets from Russia depreciation Asset share NPLs to total exchange adequacy Return on to total (% of GDP), from Jan. 1 of Russian- loans (%), position (%), ratio (%), assets (%), assets (%), 2014 or latest 2015–Feb. 29 owned banks 2015 or latest 2015 or latest 2015 or latest 2015 or latest 2015 or latest Country available 2016 (%) (%), 2014 available available available available available Armenia ● 12.3 ● 2.7 ● 28.0 ● 8.8 ● 4.2 17.1 ● −0.8 ● 28.7 Azerbaijan ● 0.2 ● 99.8 — ● 13.8 ● 43.1 ● 12.4 ● −1.4 ● 17.9 Belarus ● 0.8 ● 40.8 ● 23.7 ● 6.5 ● 12.4 ● 19.2 ● 1.7 ● 31.2 Georgia ● 7.1 ● 26.6 ● 4.8 2.7 ● 6.5 ● 17.5 2.7 ● 23.4 Kazakhstan 0.1 ● 89.7 ● 9.6 ● 9.2 ● 23.6 ● 16.2 1.5 ● 20.6 Kyrgyz Republic ● 23.5 ● 24.2 — 7.9 ● 18.4 ● 22.6 ● −1.3 n.a. Russia — ● 25.2 — ● 7.4 ● 4.6 ● 12.7 ● 0.2 ● 26.5 Tajikistan ● 32.2 ● 47.9 — ● 19.1 ● −2.7 ● 16.1 ● 2.6 ● 22.4 Sources: IMF, World Bank, Bloomberg, Bankscope, Central banks’ websites, staff calculations Notes: -For remittances: “red”: > 10% of GDP; “yellow”: 3–10% of GDP; “green”: <3% of GDP. -For currency depreciation: “red”: > 40%; “yellow”: 20–40%; “green”: <20%. -For asset share of Russian-owned banks: “red”: > 20% of total assets; “yellow”: 4–20% of total assets; “green”: <4% of total assets. -For NPLs: “red”: > 12% of total loans; “yellow”: 7–12% of total loans; “green”: <7% of total loans. -For open FX position: “red”: > 10%; “yellow”: 0–10%; “green”: <0%. -For capital adequacy ratio: “red”: < 14%; “yellow”: 14–18%; “green”: >18%. -For return on assets: “red”: < 0%; “yellow”: 0–1.5%; “green”: >1.5%. -For liquid assets: “red”: < 22% of total assets; “yellow” of total assets: 22–26%; “green”: >26% of total assets. despite poor governance, it has now become a key binding constraint on financial stability and economic growth in new sectors. Eastern ECA suffers from low fi- nancial penetration, shallow non-banking sectors and deficient financial infra- structure, including credit reporting systems, payment systems, secured transac- tion regimes and insolvency frameworks. Measures to ensure an adequate level of competition and efficiency in the banking sector, with a focus on transparency, corporate governance, increased financial intermediation are needed to diversify these economies and seize new opportunities. Although much less affected by recent adverse shocks, banks in the Euro- pean Union remain fragile. European bank stocks have experienced a significant drop since mid-2015, driven by a handful of banks (figure 1.11). The Eurostoxx 600 Bank Index has fallen by 11 percent since June 2015, and at one point touched its lowest level since December 2011. The decline was mostly driven by five banks: Unicredit (-44 percent) Deutsche Bank (-40 percent), Santander (-39 per- cent), BBVA (-36 percent) and Intesa (-26 percent). Unresolved NPLs continue to be a problem, and banks’ business models are not adjusting fast enough to the new environment. Consolidation of the sector has been moderate, and banks in many European countries have become signifi- cantly risk-averse, curtailing lending to riskier segments of the market, and park- ing their excess liquidity in low-yielding securities, waiting for regulatory and economic uncertainties to wane. The application of bail-in rules in the resolution of banks has added to the current cautionary approach. Bail-in rules during bank resolution result in the allocation of losses to shareholders and unsecured creditors, to minimize the cost of resolution for taxpayers. These rules began to be applied in 2016, with some Chapter 1: Policy Coordination Is Being Tested ●  17 FIGURE 1.11 European banks remain fragile 0.2 Year 15 15 Cumulative percentage changes 0.1 5 5 5 5 6 5 5 15 5 16 6 5 5 5 5 01 01 16 15 20 01 01 01 5 15 01 20 16 16 5 01 01 01 01 01 01 01 20 20 01 01 /2 20 /2 20 20 /2 /2 /2 /2 20 20 /2 /2 2/ /2 /2 0/ /2 /2 /2 /2 /2 4/ /12 25 2/ /17 22 25 30 27 13 2/ /2 3/ 15 18 /3 8/ /7 3/ 17 8/ 14 5 2 2 1/2 11/ 11/ 11/ 1/1 10 10 12 12 12 6/ 9/ 9/ 9/ 2/ 2/ 2/ 8/ 8/ 8/ 3/ 7/ 7/ 7/ 0 –0.1 –0.2 –0.3 –0.4 –0.5 –0.6 BBVA Deutsche Bank Intesa Sanpaolo Santander Stoxx Index Unicredit –35.62% –39.63% –25.69% –39.42% –11.23% –44.37% Source: Bloomberg negative effects in the few cases of bank resolution that have occurred. In Portu- gal, a case of discrimination among senior bondholders within the same class took place; in addition, it was ruled that credit default swaps (CDSs) insuring bonds of the resolved bank would not be triggered as a result of the application of bail-in. In Italy, resolution of small cooperative banks imposed losses on retail clients who only then realized they owned subordinated debt instead of deposits. These developments have led investors to become more risk-averse to bank-re- lated securities, including stocks. In addition to these general problems, a number of idiosyncratic reasons are responsible for the drop in European bank stocks. • Deutsche Bank’s stock price was heavily affected by sanctions related to the LIBOR scandal (for which it agreed to pay $2.5 billion in fines), and to business with countries sanctioned by the United States (for which is was fined for $258 million), plus a deep restructuring of its investment banking arm, resulting in a loss of €1.2 billion in the last quarter of 2015. • The poor performance of Spanish banks was in part due to losses from cur- rency depreciation in emerging markets where they have presence (for ex- ample, Mexico), overvalued real estate collateral, and a recent decision by the Constitutional Court to remove interest rate floors on mortgages, resulting in banks having to compensate mortgage clients. • The delayed and seemingly insufficient efforts to resolve the relatively high level of NPLs have affected Italian banks’ share prices. The NPL ratio of the Italian banking sector remains at 17 percent of total loans, or around €350 bil- lion. An agreement with the EC only partially reversed the marked downward trend in the share prices of banks, but it remains to be seen if these efforts will be sufficient to clean their balance sheets. A comprehensive approach needs to be taken to resolve the NPL burden in Europe. Such an approach could include efforts in three areas: 1) regulatory and 18  ●   World Bank ECA Economic Update April 2016 supervisory efforts to incentivize banks to restructure their NPL portfolios, through provisioning requirements and time-bound restructuring plans; 2) an overhaul of insolvency regimes to reduce obstacles and facilitate out-of-court restructuring; and 3) the development of a private market for distressed debt, with the support of public asset management companies (AMCs) if needed. Recent cases in Europe of the establishment of AMCs include Ireland and Slovenia, while the UK intro- duced an asset protection scheme, under which banks paid a fee to the govern- ment to get insurance for distressed assets that they continued to manage. 1.5 Policy makers are walking a tightrope The current policy challenges in the region are daunting. In the European Union policy coordination is being tested and even European integration itself is being challenged. In Eastern Europe and Central Asia several governments are engaged in crisis prevention or even crisis response. This final section focuses on monetary policy and fiscal policy, where the problems are perhaps not the most daunting, but are quite intricate in the current economic environment. The most complicated task is to adjust monetary policy in oil-exporting and surrounding countries. During the oil price boom most of those countries had a fixed exchange rate regime, targeting the U.S. dollar. With large and increasing inflows of oil revenues and remittances this was a stable policy regime. Any real appreciation that was required to maintain market equilibrium was created by inflation, in excess of U.S. inflation. Any surplus of foreign inflows was absorbed by rising reserves. With the collapse of the oil price and subsequently of remit- tances these fixed exchange rate regimes are no longer sustainable. Central banks have no choice but to shift towards flexible exchange rates. This allows the real exchange rate to adjust downward without forcing a deep deflationary recession. The shift towards flexible exchange rates is not without danger. In partly dollarized financial markets sharp depreciations can lead to defaults and fragility in the banking sectors, and in general depreciation can have large distributional impacts. Because of these dangers, it is tempting to adopt the shift in exchange rate regime gradually or halfheartedly. Such an approach, however, can seriously backfire. Partial adjustment of the exchange rate is likely to generate expectations of further exchange rate depreciation, which in turn will intensify the dollariza- tion of the financial sector and might trigger capital flight. Insufficient deprecia- tion also increases fiscal problems and hampers the required transformation of the economy towards more tradable production. Thus, it is essential to fully em- brace a new exchange rate regime and to deal promptly with the adverse conse- quences by addressing vulnerabilities in the banking sector. Once central banks let go of a fixed exchange rate regime, they have to adopt a credible new policy anchor. Inflation targeting is a natural choice. However, it is not obvious which inflation rate should be targeted. Many central banks in advanced economies target the consumer price index (CPI). However, that might not be the right choice for oil exporting economies at the moment. The recent rapid increase in the CPI may reflect a one-time shift in relative prices due to ris- Chapter 1: Policy Coordination Is Being Tested ●  19 ing import prices, rather than a sign of emerging inflation. Targeting the CPI, therefore, could result in overly tight monetary policy, particularly if central banks seek to quickly establish stable inflation expectations. For central banks in oil-exporting countries it seems much more appropri- ate to target the GDP deflator than the CPI. The GDP deflator measures the price change of value-added, and does not include the rise of import prices. There are two reasons why the value-added deflator is more appropriate. First, it is a better reflection of under- or overutilization of domestic production capacity. Maintain- ing a low and stable GDP deflator is equivalent to maintaining equilibrium in the domestic economy. Secondly, central banks should only be worried about a fast rise in import prices if it is the start of self-sustaining high inflation rates. This is not an academic discussion as the differences between increases in the CPI and the GDP deflator are currently large. For example, in the Russian Federation the CPI rose by 15.5 percent in 2015, while the GDP deflator rose by 6 percent (table 1.3). Targeting the CPI would lead to unnecessarily tight monetary policy. For countries that are highly dependent on oil exports an alternative to in- flation targeting is to target the oil price in local currency. That means that ex- change rate movements would compensate for any change in oil prices in U.S. dollars. This approach is very much the equilibrium solution under stable do- mestic prices, and has several advantages. First, oil prices can be immediately observed on a daily basis, so there is a lot of information about the variable that is being targeted. Second, it will reduce exchange rate speculation as the oil price is difficult to predict. Third, it might make for an easier transition for central banks that are accustomed to target exchange rates. The interventions used to achieve the target would be the same as in the previous regime, the only difference being that the level of the exchange rate that is targeted is no longer constant. The level of intervention needed to maintain a stable oil price in domestic currency is not necessarily large. Foreign exchange markets already have a ten- dency to react to dollar oil price changes by exchange rate adjustments. A clear example is what happened with the ruble in the recent past. Both monthly changes and daily changes of the ruble-dollar exchange rate were highly corre- lated with changes in the dollar price of oil (figure 1.12). Consequently, the oil price has been much more stable in rubles than in dollars. The monetary policy challenges facing the European Union are rather dif- ferent. No radical adjustment of the monetary policy regime is needed. Unlike in many countries in Eastern Europe and Central Asia, import prices are declining. As a result CPI inflation in the European Union is negligible or even negative. The ECB and other central banks have experimented with negative interest rates. The central bank of Sweden has been particularly innovative in pushing the lower bound of nominal interest rates downwards. It is not clear what the direct impact of these negative interest rates has been on investment and the recovery. However, the indirect impact through the weakening of the euro did stimulate exports, and as such contributed to the recovery. The negative policy interest rates in Europe also may have had adverse ef- fects. It may have made the banking sector even less attractive to investors in comparison to other markets. Several central banks in Europe—including the ECB—have set the policy interest rate on their deposit facilities at negative levels 20  ●   World Bank ECA Economic Update April 2016 TABLE 1.3  Large differences in 2015 between GDP and CPI deflators Difference GDP deflator CPI (percentage Change in 2015 over 2014 (percent) (percent) point) Russian Federation 6.0 15.5 −9.5 Norway −2.0 2.2 −4.2 Turkey 5.7 7.7 −1.9 Canada −0.5 1.1 −1.6 Netherlands 0.3 0.6 −0.3 Switzerland −1.3 −1.1 −0.1 Slovak Republic −0.2 −0.3 0.1 Belgium 0.9 0.6 0.3 Czech Republic 0.7 0.3 0.4 Austria 1.4 0.9 0.5 Denmark 1.0 0.5 0.5 Finland 0.4 −0.2 0.6 Latvia 0.9 0.2 0.7 Slovenia 0.2 −0.5 0.7 Italy 0.8 0.0 0.7 United States 1.0 0.1 0.9 France 1.2 0.1 1.1 Spain 0.6 −0.5 1.1 Japan 2.0 0.8 1.2 Greece −0.6 −1.7 1.2 Lithuania 0.5 −0.9 1.4 Poland 0.5 −0.9 1.4 Portugal 1.9 0.5 1.4 Germany 2.0 0.2 1.8 Hungary 1.7 −0.1 1.8 Estonia 1.4 −0.5 1.9 Sweden 2.0 0.0 2.0 Luxembourg 2.6 0.5 2.2 Ireland 3.6 −0.3 3.9 Iceland 5.9 1.6 4.3 Source: OECD quarterly national accounts; World Bank GEM database Chapter 1: Policy Coordination Is Being Tested ●  21 FIGURE 1.12 Ruble exchange rate closely follows oil price a. Monthly percentage change 20 10 Percentage change 0 10 20 30 14 14 -14 -14 -14 -14 -14 30 -14 -14 30 -14 -14 -14 28 -15 -15 30 -15 -15 30 -15 -15 31 -15 30 -15 -15 30 -15 -15 -15 29 -16 -16 - - an eb ar pr ay un ul ug ep ct ov ec an eb ar pr ay un ul ug ep ct ov ec an eb -J -O -J -O -M -M -A -A -M -M -D -N -J -D -N -J -J -A -J -J -F -S -A -F -S -F 31 31 30 31 30 30 31 31 31 31 28 31 31 31 31 31 31 Month/Year US$ per ruble Brent oil price in US$ b. Daily percentage change 6 10 Brent oil price in US$ (% change) 5 8 US$ per ruble (% change) 4 6 3 4 2 2 1 0 0 2 1 4 2 6 3 8 4 10 -16 -16 -16 -16 -16 -16 -16 -16 -16 -16 -16 -16 -16 16 16 -16 16 16 16 -16 -16 n- n- n- b- b- an eb an eb eb ar an an an eb eb ar ar ar ar ar Ja Ja Ja Fe Fe -M -M -M M M M -J -J -J -J -J -F -F -F -F -F 3- 11- 7- 3- 7- 11- 4- 8- 23 27 15 19 31 23 15 19 20 24 28 12 16 Month/Year US$ per ruble Brent oil price in US$ Source: World Bank data, staff calculations in order to encourage lending by making it costly for banks to hold excess re- serves at their central banks. While this may work in the short term, a persistent negative rate environment represents a challenge to banks’ business model, as it narrows the spread between short- and long-term interest rates, making it more difficult for banks to obtain returns from maturity transformation (borrowing funds short-term and lending long-term), thus reducing net interest margins, and undermining their profitability. By contrast, the United States has begun a period of rising interest rates, which makes the European market less attractive for in- vestors in search of higher yields. Like central banks in oil-exporting countries, central banks in the European Union might want to focus more on the GDP deflator than on the CPI. There is currently a striking difference between the two measures of inflation. For exam- ple, the German GDP deflator rose by 2 percent in 2015, significantly higher than the 0.2 percent rise in the CPI. Similarly, in Sweden GDP inflation was 2 percent, 22  ●   World Bank ECA Economic Update April 2016 while CPI inflation was 0 percent (table 1.3). This is the mirror image of what happened in oil-exporting countries. In the European Union import prices fell as a result of the collapse in oil prices, but this might have been a one-time relative price adjustment. The implication is that less monetary easing is needed once the target shifts towards the value-added deflator. The rise in housing prices relative to the CPI in 2015 in European countries is another sign that the CPI doesn’t tell the whole story. For example, in Ger- many housing prices rose 5 percentage points faster than the CPI in 2015. A simi- lar pattern is seen in many other European countries (figure 1.13). Monetary policy has more impact on the prices of domestically produced goods, and espe- cially more impact on prices of durable goods, including housing. Since in cur- rent economic circumstances relative prices are changing more than usual, cen- tral banks might want to broaden their target beyond the CPI. Like in the case of monetary policy, the fiscal challenges differ considerably between the eastern part and the western part of the region. For many countries in the eastern part debt levels are low, but their fiscal position is rapidly deterio- rating, as revenues dropped because of falling oil-revenues and tax incomes (ta- ble 1.4). And the situation might become significantly more precarious because of contingent liabilities that are linked to fragile banking sectors. For many coun- tries in the western part the opposite is true. The fiscal position is improving, but debt levels are very high. The difference within the region are striking, with the Southern and Western Europe sub regions having the highest average rates of 133 and 88 percent respectively, and Central Asia and Russia having the lowest aver- age rates at 28 and 20 respectively. However, the latter rates could rise rapidly because of contingent liabilities. Banking crises entail significant fiscal costs to FIGURE 1.13 Home prices recovering in most countries, but falling in oil-exporting countries (percentage change in home prices deflated by CPI 2015/2014) Russian Federation Greece Latvia France Croatia Belgium Finland Macedonia, FYR Poland Slovenia Netherlands Austria Country Czech Republic Switzerland Norway Spain Romania Germany United States China Slovak Republic Denmark United Kingdom Estonia Turkey Sweden Ireland 10 5 0 5 10 Percentage change in home prices Source: Bank for International Settlements (BIS), World Bank GEM, staff calculations Chapter 1: Policy Coordination Is Being Tested ●  23 TABLE 1.4  Increased debt ratios restrict fiscal space for most countries in the region Changes 2008–2015 (percent points) 2015 Levels (percentage) General General All All government government Government revenue/ expenses/ revenue/ expenses/ debt/GDP GDP GDP Debt/GDP GDP GDP Austria 18.2 1.7 2.2 86.7 50.0 52.0 Belgium 14.6 2.3 4.0 106.7 50.6 53.4 France 29.2 3.4 4.0 97.1 53.2 57.0 Western Germany 5.5 1.0 0.5 70.7 44.4 43.9 Europe Ireland 58.2 −1.2 −6.3 100.6 33.7 35.6 The Netherlands 9.2 −1.4 0.9 67.6 42.4 44.5 United Kingdom 37.1 −1.0 −1.8 88.9 36.0 40.3 Greece 88.2 5.2 −0.5 196.9 45.9 50.1 Italy 30.8 2.9 2.9 133.1 48.0 50.7 Southern Portugal 56.1 3.2 2.6 127.8 44.8 47.9 Europe Spain 59.2 0.9 0.9 98.6 37.6 42.0 Cyprus 61.7 −0.3 2.0 106.4 39.6 40.9 Bulgaria 13.6 −1.2 3.6 28.6 35.8 37.8 Croatia 53.3 1.8 4.2 89.3 43.4 48.5 Czech Republic 12.0 2.1 1.9 40.6 40.2 42.0 Central Hungary 3.4 1.2 0.2 75.3 46.4 49.1 Europe Poland 4.1 −1.7 −2.5 51.1 39.1 41.8 Romania 27.5 0.4 −2.5 40.9 32.0 33.8 Slovak Republic 25.1 5.0 5.1 53.3 39.3 41.8 Slovenia 60.2 0.4 3.8 81.8 40.8 44.5 Denmark 13.6 −2.0 3.9 47.0 51.7 54.4 Finland 29.3 3.1 10.5 61.9 55.6 58.7 Northern Sweden 7.2 −2.3 1.1 43.9 48.7 50.1 Europe Estonia 6.3 2.3 0.1 10.8 38.4 39.1 Latvia 21.6 1.7 0.0 37.8 35.1 36.5 Lithuania 23.4 −0.9 −2.9 38.8 32.9 34.1 Albania 18.2 0.2 0.4 73.3 27.0 32.1 Bosnia and 14.6 0.9 −0.6 45.5 46.5 48.1 Herzegovina Kosovo 45.5 45.5 45.5 45.5 45.5 45.5 Western Balkans FYR Macedonia 16.5 −3.7 −0.7 37.1 29.1 33.1 Montenegro 40.9 −6.2 0.5 69.9 42.2 52.2 Serbia 44.3 −1.4 0.6 76.7 40.1 44.0 (Continued next page) 24  ●   World Bank ECA Economic Update April 2016 TABLE 1.4 (continued) Changes 2008–2015 (percent points) 2015 Levels (percentage) General General All All government government Government revenue/ expenses/ revenue/ expenses/ debt/GDP GDP GDP Debt/GDP GDP GDP Armenia 31.4 0.9 3.2 46.1 21.4 25.4 South Azerbaijan 13.3 −24.3 3.6 20.6 26.8 34.7 Caucuses Georgia 21.8 −2.6 −3.2 45.4 28.1 29.5 Kazakhstan 11.5 −7.9 −3.5 18.3 20.4 23.6 Kyrgyz Republic 11.5 5.5 8.9 60.0 35.8 38.2 Central Tajikistan 2.9 4.1 1.0 32.9 26.3 28.2 Asia Turkmenistan 15.9 −7.0 3.9 18.7 13.8 14.8 Uzbekistan −1.1 −5.4 2.2 11.6 35.3 35.2 Russia 12.4 −5.3 5.3 20.4 33.9 39.6 Turkey −7.8 3.8 2.0 32.1 35.6 36.5 Belarus 18.8 −9.3 −5.0 40.4 41.4 43.8 Other Eastern Moldova 25.6 −4.6 −1.6 44.8 36.0 39.9 Europe Ukraine 74.7 −1.5 −0.4 94.4 40.8 45.0 Source: IMF World Economic Outlook (WEO) database stabilize the banking sector, particularly in the absence of an adequate frame- work for bank resolution, including burden sharing mechanisms for sharehold- ers. This all means that in most countries in Europe and Central Asia fiscal space is limited, albeit for different reasons. Current circumstances ask for the right type of fiscal spending, rather than for large amounts of general fiscal stimulus. Priorities of fiscal policy in the eastern part of the region are the protection of the most vulnerable households and the facilitation of the transition from non-tradable to tradable production. Countries such as Belarus, the Kyrgyz Republic and Russia actually strengthened their social protection to counter poverty increase. Under the pressure of fiscal consolidation, Armenia, Belarus, and Ukraine are planning to raise utility tariffs to cost recovery, but the complementing mitigation measures will help soften the negative impact on households. Government investments in trade facilitation are currently much more effective than stimulus of the domestic construction sector, even if the latter is tempting as many jobs are being lost in the construction sector. Priority of fiscal policy in the western part of the region is stimulus of private investment that is still at subdued levels. Chapter 1: Policy Coordination Is Being Tested ●  25 Notes 1. See, for example, Constantinescu, Mattoo, and Ruta (2015), “The Global Trade Slowdown”, World Bank Policy Research Working Paper, 7158. 2. Source: http://data.unhcr.org/syrianrefugees/regional.php, Data updated March 22, 2016 3. Source: http://ec.europa.eu/eurostat/statistics-explained/index.php/Asylum_quarterly_ report. 4. Source: http://europa.eu/rapid/press-release_IP-15-5596_en.htm 5. Source: http://ec.europa.eu/dgs/home-affairs/what-we-do/policies/european-agenda- migration/background-information/docs/20160316/relocation_and_resettlement_-_ state_of_play_en.pdf 6. Source: http://europa.eu/rapid/press-release_MEMO-16-963_en.htm 7. For a short brief on economic impact of migration see (OECD, 2014) and (IMF, 2015): https://www.oecd.org/migration/OECD%20Migration%20Policy%20Debates%20 Numero%202.pdf and h t t p : / / w w w. i m f . o rg / e x t e r n a l / n p / g 2 0 / pdf/2015/111515background.pdf/ 2 China’s Impact on Europe and Central Asia Summary • The slowing pace of GDP growth in China has important implications for countries in Europe and Central Asia, but they are not all negative. This is because the slowdown reflects lower growth potential that reduces China’s exports as much as China’s imports. Lower potential growth in China creates some opportunities in the western part of ECA as producers in these countries will face less competition at home and in third markets, but it will probably hurt eastern countries as demand for their natural resource will decrease. • The reduction of labor intensive Chinese exports will affect factor prices dif- ferently: wages, especially those for lower skilled workers, may benefit rela- tive to capital income. • When the structural slowdown is accompanied by a rebalancing of the Chi- nese economy (more consumption, less investment, increasing skill levels of workers, more outward FDI), the eastern part of the region will likely benefit more than the western one. • Recent real depreciations in ECA represent a strong force for changing trade relations with China. Countries in the region become more competitive and increased domestic production of tradables will substitute imports and in- crease market shares abroad. • Shifting resources out of non-tradables into tradables and seizing these op- portunities requires policy reforms. Facilitating mobility in labor markets and flexibility in domestic banking are particularly important. This as adjustment is complicated by rigidities and vested interests that have emerged during the long period of high oil prices. 27 28  ●   World Bank ECA Economic Update April 2016 2.1 Introduction After decades of exceptionally strong economic growth, China became in 2007 the largest exporter in the world. China is currently the second largest importer. Its import market is roughly the size of the imports of the other BRICS (Brazil, the Russian Federation, India, and South Africa), Japan, and Turkey combined. The Chinese economy has become a leader in other dimensions too. Invest- ment in China was in 2015 four times the level in Japan, and exceeds investment in the United States and the European Union by 35 and 25 percent, respectively. Exceptionally strong investment demand in China has created large export op- portunities for Germany and other western European countries that are special- ized in the production of investment goods. In many metal markets China repre- sents more than 50 percent of global demand. This has created big export opportunities for resource-rich countries in Central Asia. In 2009, immediately after the global financial crisis and in the midst of the Great Recession, China engaged in massive domestic stimulus. The volume of China’s imports increased by 4.9 percent, while import volumes outside China declined by 12.4 percent. Since 2009 China’s import volumes have increased a further 80 percent, compared with a global increase of 36 percent. Because of this dominant role of the Chinese economy, it is not surprising that China’s current economic slowdown, combined with signs of vulnerability in China’s financial sector, has triggered serious concerns throughout the global economy. And it is not surprising that countries in Europe and Central Asia (ECA) are anxious, as their links with China through trade and FDI have intensi- fied over time. This chapter explores these links between China and the ECA region, against the backdrop of recent developments. The relevant developments go well be- yond China’s slowdown. They also include the ongoing changes in the structure of the Chinese economy: the shift from investment towards consumption (rebal- ancing); the shift from inward FDI towards outward FDI; and the increasingly higher skill levels of the workforce in China. Moreover, recent developments in the ECA region itself will also affect the relation with China. In particular, the sharp depreciations in oil-exporting and neighboring countries have made these countries significantly more competitive vis-à-vis Chinese producers. Simulations presented in this chapter suggest the following conclusions: • The character of the slowdown in China matters. The impact of a cyclical slowdown (caused by a sudden drop in Chinese domestic demand) on the ECA region differs from the impact of a structural slowdown (caused by slow- er productivity growth). The main difference is in the impact on trade balance. A structural slowdown implies a reduction of production and thus of both imports and exports, with ambiguous but probably small effect on the trade balance. A cyclical slowdown is triggered by a reduction of demand and thus is associated to a reduction of imports but not of exports with an increase in the trade surplus. This has clearly different implications on trade balance – i.e. Chapter 2: China’s Impact on Europe and Central Asia ●  29 on overall Chinese demand of global production – than a structural slow- down. So far, the current slowdown has more structural than cyclical charac- teristics. A structural slowdown is less negative for the ECA region, but also poses challenges, because it leads to shifts in the sectoral composition of trade. Accommodating such shifts requires mobility in labor markets and flexibility in domestic banking sectors and capital markets. • The impact of a slowdown in China due to lower productivity growth would differ across countries, sectors, and factors of production. Slower pro- ductivity growth in China would benefit the western part of the ECA region by improving the competitive position of their manufactures exports, but hurt the eastern part of ECA by reducing demand for their natural resources ex- ports. China’s slowdown also would reduce the return to investment relative to wages, and improve the wages of unskilled workers relative to skilled workers. The reason is that China’s rapid export growth has been low-skilled, labor-intensive. That has put downward pressure on wages in other countries. As China’s export growth loses pace then that downward pressure eases. • A rebalancing of the Chinese economy could benefit eastern ECA, while hurting western ECA. China’s efforts to become a high-income economy will require increasing consumption relative to investment and shifting towards the production and export of high-skilled manufactures. Such a rebalancing would hurt western ECA by reducing demand for their capital goods exports and increasing competition for high-skilled manufactures exports in general. At the same time, rebalancing could increase opportunities for eastern ECA’s low-skilled manufactures and improve their access to outward FDI flows from China. • The new opportunities created by sharp real depreciations in ECA countries can easily be underestimated. The links between China and ECA are not only important because of changes in China, but also because of changes in ECA. That is especially clear for the recent depreciations. These real depreciations, caused by reduced oil revenues and reduced remittances, create opportunities for import substitution and increased penetration of Chinese markets. But es- pecially in oil exporting countries, these opportunities can be impeded by in- flexibilities and vested interests that have emerged during a long period of high oil prices. • The remainder of this chapter consists of six sections. The first one describes China’s evolving role in the global economy and characterizes recent develop- ments in China’s economy. The following section considers the changing trade links between the ECA region and China. The following three sections present simulations using a global econometric gravity model and a global general equilibrium model. These simulations illustrate the possible impact on ECA of real depreciations following a collapse in oil prices, of the slow- down in China, and of the transformation in the Chinese economy. A final section concludes. 30  ●   World Bank ECA Economic Update April 2016 2.2 China: a dominant economic power in transition After 25 years of rapid economic growth, China became in 2007 the world’s largest exporter and is currently the world’s second largest importer after the United States. Currently, China exports almost 60 percent more than the United States, the second largest exporter, and 75 percent more than Germany, the world’s third largest exporter. A quarter of the world’s fixed investment takes place in China, 30 percent more than in the European Union and 40 percent more than in the United States. In many metal markets China represents more than half of global demand. Because of China’s dominant position in the global economy, disruptions in China’s economy can have worldwide consequences. Two concerns cur- rently stand out: • China’s GDP growth, which averaged 10.5 percent per year between 1990 and 2010, has fallen below 7 percent. Even during the late 1990s, at the height of Asian financial crisis, China’s GDP growth remained above 7.5 percent. Dur- ing the global financial crisis in 2009, when global GDP contracted for the first time in at least 50 years, China’s GDP expanded more than 9 percent, fueled by exceptionally strong domestic stimulus. The recent slowdown is unsettling mar- kets and raising policy makers’ concerns over the impact on other economies. • The high investment rate in China since 2009 has been associated with falling returns to capital and emerging NPLs, which will test the solidity of the bank- ing sector, and which might expose vulnerabilities associated with the shad- ow banking sector. A rebalancing of China’s economy, marked by a reduction of investment in favor of consumption, is essential to achieve the sustainable growth required to become a high-income economy. Other important ele- ments of this rebalancing addressed below include the shift from inward FDI to outward FDI, and the shift from low-skill intensive production to high-skill intensive production. All of these changes could have far-reaching conse- quences for the rest of the world. Reduced competitiveness as the driver of China’s slowdown Understanding the character of the slowdown in China is essential for analyz- ing its impact on the global economy. In short-term macroeconomic analysis, slower GDP growth is typically viewed as reducing imports and thus reducing demand for other countries’ exports. From this perspective, slower growth in China is exacerbating the difficulties facing the global economy, which is still struggling to recover fully from the global financial crisis. However, for two re- lated reasons a slowdown in China’s GDP is not necessarily a slowdown in de- mand for the rest of the world. The first reason is that China’s domestic demand can outpace its GDP growth, implying strong net imports from the rest of the world. The second reason is that slower GDP growth can be caused by supply- side phenomena, resulting in slower growth of China’s production capacity. This Chapter 2: China’s Impact on Europe and Central Asia ●  31 implies that not only imports but also exports are being reduced. Because of these reasons slowing GDP growth can actually coincide with accelerated demand for goods produced in the rest of the world. To reflect changes in China’s production capacity as cause of its GDP slowdown, this report doesn’t use short-term, de- mand-oriented models, but gravity models and general equilibrium models in which the supply side is explicitly taken into account. China’s recent slowdown did not reflect a reduction in demand for the rest of the world. Indeed, China has made a net contribution to global demand since the onset of the financial crisis. Examining the relationship between the growth of GDP and domestic demand provides some insight into China’s impact on the global economic cycle. At the height of the global boom (the three years from 2005 to 2007), China’s GDP expanded by 12.7 percent per year but domestic demand by only 9.5 percent, reflecting a strong positive contribution of net exports to China’s GDP growth. Thus, China’s exports absorbed a significant part of strong global demand that was only partially compensated by China’s import demand. How- ever, the opposite happened at the depth of the global financial crisis in 2009: Chi- na’s GDP expanded by 9.2 percent but domestic demand increased by 16.4 per- cent, reflecting exceptionally strong domestic stimulus. Although China’s GDP growth had slowed compared with the period before the crisis, China contribu- tion to demand for the rest of the world had actually increased substantially. China’s contribution to global demand has been countercyclical before and after the financial crisis. In figure 2.1, the blue bars show the cyclical component of global GDP growth, calculated as actual growth minus a seven-year moving FIGURE 2.1 China’s domestic demand has been countercyclical to the global cycle 6 4 2 Percentage points 0 2 4 6 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Year Contribution of domestic demand to China's GDP growth, in excess to GDP growth Cyclical component of global GDP growth Source: World Development Indicators, World Bank, and calculations by the authors 32  ●   World Bank ECA Economic Update April 2016 average of global growth. The red bars show the contribution of domestic de- mand to China’s GDP growth, in excess of GDP growth. So, for example, in 2009 GDP growth in China would have been 5.5 percentage points higher if all domes- tic demand growth would have been translated into GDP growth. In reality, however, net exports subtracted 5.5 percentage points from GDP growth. The implication of that negative contribution of net exports was that China, on a net basis, stimulated demand in the rest of the world. China’s slowdown likely reflects slower growth of productive capacity, which has important implications for the impact on the global economy. Rapid growth in China had been driven by technological catch up in the manufacturing sector and an abundant supply of unskilled labor, as workers in the countryside were attracted to higher-paying jobs in manufacturing centers. Maintaining the pace of expansion is becoming difficult, however, as the gap with the technologi- cal frontier narrows and labor becomes scarcer. The growth rate of productive capacity, as estimated by a production function with filtered trends in total factor productivity1, appears to be falling (figure 2.2). The slowdown in potential growth is confirmed by recent data on exports. The volume of exports from China did not increase during the last 12 months, while growth during the preceding 10 years, including the period of the great recession, had averaged 8 percent per year. Instead of gaining market share in global trade, as it did for several decades, China is now losing market share. Ap- parently, it is difficult for Chinese companies to continue to increase their com- petitiveness vis-à-vis foreign suppliers. A productivity-led slowdown in China has mixed implications for the rest of the world. Slower export growth increases opportunities for producers of manufactures in other countries, who find it easier to compete with China at home and in third countries. On the other hand, China’s imports also are decel- erating, which reduces effective demand in the rest of the world, especially for FIGURE 2.2 Slowdown in China coincides with decelerating potential growth 15 13 Annual percentage change 11 9 7 5 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 20 20 20 20 20 20 20 19 20 19 19 20 19 20 19 19 19 20 20 20 20 20 20 Year Potential GDP growth Actual GDP growth Source: World Development Indicators, World Bank, and calculations by the authors Chapter 2: China’s Impact on Europe and Central Asia ●  33 the exporters of natural resources in the ECA region. Slower export growth by China also hurts consumers worldwide, who had benefited from cheaper goods due to fast productivity growth in China. The massive domestic stimulus and increasing scarcity of low-skilled labor has driven a real appreciation of China’s currency, which has become the main reason for rising incomes in China. China’s GDP increased in nominal terms from only 3 percent of the GDP in the European Union in 1990 to 65 percent in 2015 (figure 2.3). In the 17 years before the global financial crisis, almost 60 per- cent of the relative increase of China’s GDP was caused by faster volume growth. The remainder was the result of real appreciation.2 Between 2008 and 2015, how- ever, more than 70 percent of the relative rise in China’s GDP was caused by real appreciation in China vis-à-vis the European Union. This real appreciation is con- sistent with the description of the sharp slowing of China’s export growth since the global crisis as a supply shock. Rebalancing in China Ongoing structural changes in China’s economy may have an even greater im- pact on the global economy than the slowdown in China’s productivity growth. These structural changes are needed to either correct built-up imbalances, or to prepare for future growth in more advanced and higher value-added segments of the global economy. Three changes will have a particularly significant impact on the ECA region: the shift from investment to consumption, the shift from inward to out- ward FDI, and the shift from low-skill intensive to high-skill intensive production. The coming decline in China’s investment rate has important implications for ECA. Prior to the financial crisis, the level of China’s investment was roughly appropriate given its rapid growth. During the 1990s, investment averaged close FIGURE 2.3 China is catching up to the European Union 80 70 China's nominal GDP as percentage 60 of EU's nominal GDP 50 40 30 20 10 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 20 20 20 20 19 20 20 20 19 20 19 19 20 19 20 19 19 19 19 20 20 19 20 20 20 20 Year Starting share Cumulative volume e ect Cumulative price e ect Source: World Development Indicators, World Bank, and calculations by the authors 34  ●   World Bank ECA Economic Update April 2016 to 35 percent of GDP, typical for an economy growing at rate of 10 percent per year. In 2003, at the start of the global boom, China’s investment rate increased to around 40 percent, which supported an acceleration of GDP to 12 percent per year during the boom. However, after the global financial crisis China’s invest- ment rate increased to 45 percent, while GDP growth declined. Given that lower growth path, the current investment rate may be 15 percentage points above its equilibrium level. This implies a rapid increase in the capital output ratio, inevi- tably leading lower return to that capital. Even if the adjustment is smooth and China is able to increase consumption at the same pace as it decreases invest- ment, the consequences for the Europe and Central Asia of this rebalancing can be significant. The challenges are especially large for the German economy, which is specialized in the production of investment goods, and which has a large share of China’s market. Likely increases in outward FDI from China represent an important oppor- tunity for many countries in ECA. Only a few years ago outward FDI from China was negligible, while inward FDI was around 3 percent of China’s GDP. This has changed dramatically. In 2015 outward FDI amounted to US$ 167 billion, roughly 70 percent of inward FDI. Soon outward FDI is expected to exceed in- ward FDI. The rapid rise of direct investment abroad reflects an internationaliza- tion of Chinese companies that will allow them to capture a larger part of the higher end of the value chain. While in the past Chinese firms gained access to foreign technology and to international markets through inward FDI, they are increasingly gaining this access through outward FDI, as many other economies that moved towards high-income status have done before. Of particular impor- tance to the eastern part of the ECA region is China’s objective to develop a new Silk Road connecting Asia and Europe. China’s comparative advantage is shifting from low-skilled to high-skill manufactures. Education levels have risen sharply in China over the past 15 years, increasing the supply of high-skilled workers (figure 2.4). In addition, the aging of China’s population and slower internal migration from rural to urban FIGURE 2.4 Since 2000 60 education levels in China upper secondary or higher education are sharply increasing Percentage of 25–29 year olds with 50 40 30 20 10 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Year Source: World Development Indicators, World Bank, and calculations by the authors Chapter 2: China’s Impact on Europe and Central Asia ●  35 areas is making labor less plentiful. These changes in China will have a signifi- cant impact on the international division of labor. Central Asia will find it easier to compete with China in sectors where China historically has been strong. On the other hand, China increasingly will become competitive in sectors where Eu- rope used to have a comparative advantage. 2.3 ECA’s links with China ECA has become more open to trade and is more open than other regions. Both exports and imports from ECA increased by almost two and a half times from 1995 to 2014, at constant prices. By 2014, total trade equaled 80 percent of GDP, making ECA (after the Middle East and North Africa) the region most open to trade (figure 2.5). However, ECA countries trade more with each other than with the rest of the world: two-thirds of ECA’s imports come from other ECA countries, reflect- ing proximity, integration of countries within the European Union, and the his- torical ties among the countries that were members of the Soviet Union.3 China’s trade with ECA has grown rapidly over the past 20 years, and China is ECA’s largest import partner outside of the region. China’s share of ECA’s FIGURE 2.5 ECA has become more open to trade and is more open than other regions 100 90 80 70 Trade as share of GDP (%) 60 50 40 30 20 10 0 00 02 03 04 05 06 07 08 09 90 92 93 94 95 96 98 99 01 10 12 13 14 97 91 11 20 20 20 20 19 20 20 19 20 19 19 20 20 19 19 19 19 19 20 20 20 20 20 19 20 Year EAP ECA LAC MNA SAR SSA World Source: World Development Indicators, World Bank, and calculations by the authors Note: EAP=East Asia and the Pacific, ECA=Europe and Central Asia, LAC=Latin America and the Caribbean, MNA=Middle East and North Africa, SAR=South Asia, SSA=Sub-Saharan Africa. 36  ●   World Bank ECA Economic Update April 2016 imports increased from 2 percent in 1996 to 8 percent in 2014. Within ECA, the countries in Central Asia have experienced the largest increase in the share of imports coming from China, from 5 percent in 1996 to 29 percent in 2014. 4 But China’s share of imports also increased sharply in Russia (from 4 percent to 17 percent) and Turkey (1 percent to 12 percent), and more than tripled in every ECA sub-region (figure 2.6). Fully 98 percent of ECA’s imports from China are manufactures, mostly imported by Western Europe. China’s share of ECA exports has also increased but by less than for ECA’s imports. In 2014, ECA’s exports to China were 4.5 percent of the total, or only about three-fifths of ECA’s exports to North America and about the same level as exports to the Middle East and North Africa. Again, Central Asia and Russia have the strongest trade ties with China: China’s share of Central Asia’s exports was 19 percent, and its share of Russian exports 8 percent (figure 2.7). The composition of ECA’s exports to China has shifted towards natural re- sources. The share of natural resources exports (coal and coal products, oil and pe- troleum, natural gas and minerals) in ECA’s exports to China increased from 1 per- cent in 1996 to 12 percent in 2014 (figure 2.8). This largely reflects the boom in production of natural resources during this period in Central Asia and Russia, and leads to an increase of natural resources in exports not only to China but also FIGURE 2.6 China’s share of imports by ECA has expanded rapidly, 1996–2014 (share of imports from China in total imports, percent) 35 30 Share of imports from China in total imports (%) 25 20 15 10 5 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 1996 2014 Source: UN COMTRADE, United Nations, and calculations by the authors Note: See Annex A for regional classification Chapter 2: China’s Impact on Europe and Central Asia ●  37 FIGURE 2.7 China’s share of ECA’s exports is less than its share of imports, 1996–2014 (share of exports to China in total exports, percent) 20 18 share of exports to China in total exports, percent 16 14 12 10 8 6 4 2 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Year 1996 2014 Source: UN COMTRADE, United Nations, and calculations by the authors Note: See Annex A for regional classification FIGURE 2.8 ECA’s exports to China are mostly manufactures 80 (percent of total exports) 70 Percent of total exports 60 1996 50 2014 40 30 20 10 0 Agriculture Natural resources Low skill High skill manufactures manufactures Exports Source: UN COMTRADE, United Nations, and calculations by the authors Note: See Annex A for sectoral classification 38  ●   World Bank ECA Economic Update April 2016 to the rest of the world. If developments in China affect the world prices of natu- ral resources, this may have implications on ECA’s exports of natural resources not only to China, but also to the rest of the world. Nevertheless, while China is more likely to affect prices of non-oil resources, for example, metals, its weight in the oil and gas market is less dominant, and the latter account for a much larger share of exports, both in growth and levels. Furthermore, ECA’s exports to China remain mostly high-skilled manufactures, largely from the European Union. High-skilled manufactures accounted for 72 percent of ECA’s exports to China in 2014, down only slightly from 76 percent in 1996. The experience of Germany and Kazakhstan illustrate the intensification of ECA’s trade with China. Together with Russia, China has been among the top export destinations and import origins for most ECA countries. Nevertheless, its importance as a trade partner has increased significantly compared with other top trade partners within and outside the region. Germany’s exports to China increased by almost six times from 2000 to 2014 at constant prices, compared to almost four times to Russia (figure 2.9). Most of Germany’s exports to both coun- tries were high-skilled manufactures. Kazakhstan’s exports to China more than FIGURE 2.9 Germany’s and Kazakhstan’s trade with Germany China increased sharply, 100,000 2000–14 (constant prices) 90,000 80,000 Million US$ (2005) 70,000 Agriculture 60,000 50,000 Natural resources 40,000 30,000 Low-skill manufacturing 20,000 10,000 High-skill manufacturing 0 2000 2014 2000 2014 2000 2014 2000 2014 China Russia China Russia Exports Imports Kazakhstan 8,000 7,000 Million US$ (2005) 6,000 5,000 4,000 3,000 2,000 1,000 0 2000 2014 2000 2014 2000 2014 2000 2014 China Russia China Russia Exports Imports Source: UN COMTRADE, United Nations, and calculations by the authors Note: See Annex A for sectoral classification Chapter 2: China’s Impact on Europe and Central Asia ●  39 tripled, largely reflecting increased exports of natural resources, while Kazakh- stan’s exports to Russia declined by around a quarter, as natural resource exports almost halved. This may reflect growing self-sufficiency in Russia due to oil, gas, and minerals discoveries. Similarly, imports from China by both Germany and Kazakhstan increased much more rapidly than imports from Russia over 2000 to 2014 (Germany’s imports from Russia actually declined slightly).5 For both Germany and Kazakhstan, the more rapid increase in exports to China than to Russia from 2000 to 2014 was due to more rapid growth in GDP per capita in China. The result of the gravity model described in Box 2.1 indicates that a major factor that drives the intensification of trade between ECA and China is the higher GDP growth in China, compared with that of other trade partners such as Russia. This growth is partially offset by the smaller real depreciation of the currencies of Germany and Kazakhstan against the renminbi than the ruble, which favored trade with Russia (figure 2.10). There are, of course, other factors that cannot be explained in the model which drive the growth of exports to China. For high-skilled manufactures, for example, these factors reduce the percentage point difference in the rate of growth between Germany’s exports to China and to Russia. In Kazakhstan, by contrast, the more rapid growth in high-skill manufactures exports to China than to Russia is almost entirely due to unexplained factors. FIGURE 2.10 More rapid Growth of Germany's exports to China relative to Russia 2000–2014 growth of exports to China 10 than to Russia reflected Percentage point di erence 8 China’s booming per 6 capita income 4 2 0 –2 All Low-skill manufacturing High-skill manufacturing GDP per capita –4 Population –6 –8 Relative exchange rate –10 Other Total change Growth of Kazakhstan's exports to China relative to Russia 2000–2014 18 Percentage point di erence 16 14 12 10 8 6 4 2 0 –2 All Low-skill manufacturing High-skill manufacturing Source: Results from the gravity model with data from UN COMTRADE, United Nations Note: See Annex A for sectoral classification 40  ●   World Bank ECA Economic Update April 2016 Kazakhstan appears to have considerable potential to increase exports to China, while Germany may not. By 2014, the level of Germany’s manufactures exports to China were more than twice the level predicted by the fundamental determinants of trade represented in the gravity model, including the economic and population sizes of the both Germany and China (the supply and demand factors) as well as other historical and economic links between them such as co- lonial link, common language, belonging to the same regional trade agreement, and the distance between the two countries. Thus, the potential for further in- creases of German exports to China may be limited. On the other hand, the actual exports of Kazakhstan to China, particularly in agriculture and natural resources, are lower than the values predicted by the gravity model, and the differences can be a significant share of total Kazakhstan exports (19.8 and 21.8 percent of total agriculture and natural resources exports, respectively) (figure 2.11). The difference between the predicted and actual exports can be due to many country-specific factors, such as relative productivity or institutional framework, many of which can be influenced by policies. In other words, Kazakhstan may have a significant opportunity to boost exports to China going forward. FIGURE 2.11 Kazakhstan has greater potential than Germany to increase exports to China (exports to China at constant prices) Germany Kazakhstan 90,000 10,000 80,000 9,000 70,000 8,000 7,000 US$ million US$ million 60,000 6,000 50,000 5,000 40,000 4,000 30,000 3,000 20,000 2,000 10,000 1,000 0 0 Agriculture Natural Low-skill High-skill Agriculture Natural Low-skill High-skill resources manufacturing manufacturing resources manufacturing manufacturing Actual exports Predicted exports Germany Kazakhstan 9 35 Percent of total exports 8 Percent of toal exports 30 7 25 6 5 20 4 15 3 10 2 1 5 0 0 Agriculture Natural Low-skill High-skill Agriculture Natural Low-skill High-skill resources manufacturing manufacturing resources manufacturing manufacturing Actual share Predicted share Source: UN COMTRADE, United Nations, and calculations by the authors Note: Predicted level of trade based on gravity model with data from UN COMTRADE, United Nations. See Annex A for sectoral classification. Chapter 2: China’s Impact on Europe and Central Asia ●  41 BOX 2.1 Using a gravity model to explain trade The gravity model is an econometric approach to The relationship between trade in each of the explaining trade relationships between two coun- commodity groupings listed above and the inde- tries on the basis of their size, distance, and other pendent variables is estimated using a bilateral variables. The model is inspired by Newton’s Grav- trade matrix encompassing most countries of the itational Law which states that the gravitational world for the period 1996–2014 (see Annex A for force between two objects is proportional to their more details). In the main text, we use the gravity masses and inversely proportional to the square of model to explain both the evolution of trade over the distance. Key appealing features of the grav- time and the level of 2014. The estimated coeffi- ity approach, as applied to international trade, are cients can also be used to conduct ‘simulations’. In that (i) it takes into account the supply side—i.e. other words, it is possible to answer questions like: that trade flows are determined, amongst other “what would be the impact on trade flows if the variables, by the GDP of the exporting coun- real exchange rate were to change while all other tries—and (ii) that countries with similar economic variables remain fixed?” size trade more with one another (similar tastes The gravity model has achieved considerable between countries with close levels of develop- success in explaining trade relationships since its ment). In the version of the model used here, bilat- introduction by Jan Tijnbergen in 1962.6 One limi- eral trade flows are estimated as a function of GDP tation of the model used here is that the results per capita and population of origin and destina- cannot take into account some of the endogenous tion countries, the real exchange rate and distance relationships. While most of the independent vari- between the two countries, and whether they are contiguous, have a colonial link, have a common ables are truly exogenous (e.g. distance), the real official language, are both in the European Union, exchange rate is not. Thus, the change in trade or participate together in another regional trade flows generated by a change in the real exchange agreement. The model also includes dummy vari- rate will not reflect the impact of the real exchange ables for the year and country, to control for influ- rate change on GDP. Another drawback is that ences on trade that are specific to a particular year each bilateral flow is modeled as independent of (e.g. the global financial crisis) and country. Sepa- other. For example if an income shock to China rate estimations are done for agricultural products, causes its exports to Germany to decline, the grav- natural resources, low-skilled manufactures, high- ity model does not allow the other trade partners skilled manufactures, and total trade. of Germany to fill in this potential gap. Exports remain well below potential in several ECA countries. Applying a similar analysis to the ECA region as a whole, several countries appear to have substantial opportunities for intensifying their trade with China. In 2014, exports to China from Russia, the South Caucasus, and Central Asia were at or below predicted across all four sectors (agriculture, natural resources, low-skilled manu- factures, and high-skilled manufactures), and exports to China from Turkey, East- ern Europe, and Western Balkans were at or below predicted in three out of the four (figure 2.12). By contrast, Western Europe’s exports of manufactured goods (which make up the bulk of their exports) considerably exceeded prediction. ECA’s imports from China in 2014 were much closer to prediction than were ECA’s exports to China. For example, the actual level of ECA’s imports of low- skilled manufactures from China was either close to or significantly above pre- diction in all sub-regions (figure 2.13). The actual level of ECA’s imports of high- 42  ●   World Bank ECA Economic Update April 2016 FIGURE 2.12 Eastern ECA may have greater potential than western ECA to increase exports to China (exports to China by sector from ECA sub-regions) 2,500 Agriculture 2,000 US$ million 1,500 1,000 500 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 35,000 Natural resources 30,000 25,000 US$ million 20,000 15,000 10,000 5,000 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 25,000 Low-skill manufacturing 20,000 US$ million 15,000 10,000 5,000 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 160,000 High-skill manufacturing 140,000 120,000 US$ million 100,000 80,000 60,000 40,000 20,000 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region Actual Predicted Source: UN COMTRADE, United Nations, and calculations by the authors Note: Predicted exports based on gravity model with data from UN COMTRADE, United Nations. See Annex A for sectoral and regional classification. Chapter 2: China’s Impact on Europe and Central Asia ●  43 FIGURE 2.13 China’s potential to increase import penetration in ECA is limited (imports from China by sector from ECA sub-regions) 1,200 Agriculture 1,000 US$ million 800 600 400 200 0 Central Central Eastern Northern Russia South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 140,000 High-skill manufacturing 120,000 100,000 US$ million 80,000 60,000 40,000 20,000 0 Central Central Eastern Northern Russia South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 50,000 Low-skill manufacturing 45,000 40,000 35,000 US$ million 30,000 25,000 20,000 15,000 10,000 5,000 0 Central Central Eastern Northern Russia South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 400 Natural resources 350 300 US$ million 250 200 150 100 50 0 Central Central Eastern Northern Russia South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region Actual Predicted Source: UN COMTRADE, United Nations, and calculations by the authors Note: predicted level of imports from China based on gravity model with data from UN COMTRADE, United Nations. See Annex A for regional and sectoral classification. 44  ●   World Bank ECA Economic Update April 2016 skilled manufactures from China was slightly lower than predicted in a few of the sub-regions, although the differences were small. This may indicate that China’s ability to further penetrate ECA’s domestic markets is limited, and more so in high-skilled than in low-skilled manufactures. In summary, many ECA countries appear to have considerable potential to export more to China, while China’s import penetration of ECA’s markets is likely to slow. Countries in eastern ECA have particularly low levels of exports relative to what is estimated by the gravity model. Exports to China from the more developed countries of Western Europe, however, appear to be close to or higher than potential, indicating more limited opportunities for future export growth. 2.4 Gaining competitiveness vis-à-vis China Exchange rate depreciation through early this year significantly increased the competitiveness of ECA’s tradable production. The recent decline in the oil price has sharply reduced economic activity in oil-exporting countries in ECA, which in turn has reduced exports from, and remittances inflows to, other coun- tries in the region. While lower oil prices represent a significant welfare loss for these countries, adjustment to lower oil prices also creates opportunities. Falling export revenues and remittances receipts drove currency depreciations in these countries that were much greater than differences in inflation rates with major trading partners. In addition, other ECA countries also experienced currency de- preciation in 2015, for example due to slow recovery in the European Union and the crisis in the Ukraine. Thus, the competitiveness of domestic production of tradables, both vis-à-vis imports and in export markets, improved in all ECA countries. Given the continued real appreciation of the renminbi against most major currencies, the real depreciation of ECA’s currencies vis-à-vis China’s has been large, ranging from about 5 percent for Tajikistan to 46 percent for Azerbai- jan (figure 2.14). Exchange rate depreciation, however, does not automatically result in an increase in the domestic production of tradables. Entrepreneurs have to be able to shift investment to tradables, and workers have to move into jobs in tradables sectors with rising wages. Thus, limits on firm start up (e.g. due to a cumbersome or corrupt administrative machinery handling necessary approvals), a low level of financial sector development, and rules that discourage hiring (e.g. require- ments of excessive termination payments) can slow the output response to ex- change rate depreciation. Such impediments may be particularly important in oil-exporting countries, where the dominant role of government during a pro- longed period of high oil prices may have encouraged rent seeking and discour- aged entrepreneurial activity. On the other hand, it is important to avoid under- estimating the potential for increases in domestic production of tradables in response to a large real depreciation. The competitive position of most ECA coun- tries has changed radically over the past year, and a major goal of policy should be to facilitate the changes in economic structure that are necessary to capitalize on this opportunity. Chapter 2: China’s Impact on Europe and Central Asia ●  45 FIGURE 2.14 ECA currencies depreciated sharply over past year (percent change in real exchange rate with China, Jan–Feb 2015 to Jan–Feb 2016) Country a in ov n eg io rz R m G ain tan rat Fi nd nia, lic ic ic FY o ia He jik ia do bl bl la o b r s e N tug urg Ire ed epu Tu nd epu M tria nds Uk akh Fed Un ania epu Ta en ing Cr uan nd Ru aru an an r bo x rk ly ny re ia ac R rg a m K s la la R th a to ia a ry et al b R er ia Cz gium l ij pr n ol a eo e z n s s Ky ov H ece Sl nia Fr and Sl atia Lu ma Be rba Ro us G an Cy de Bu nce Au her Es en M rgi Li nia ist Ita ma Sp ga M ak Sw ey Ar ted Po yz Po em Ka sia G gar Al ch De ia Bo in Be ta d m rk e ov ov un n tv e e s al nl i l a l Az La 0 –5 –10 –15 Percent change –20 –25 –30 –35 –40 –45 –50 Source: Global Economic Monitor, World Bank, and calculations by the authors Note: The 2016 exchange rate data are not available for all countries, in which case the latest data (in 2015) are used. The increase in the potential level of oil-rich ECA’s total exports as a result of the real depreciation of currencies in early 2016 is expected to be significant. For example Central Asia and Russia are expected to increase their total manu- facturing exports by more than 10 percent.7 The increase in potential exports to China is even greater, because ECA exchange rates depreciated by more in real terms against the renminbi than against the average of other currencies. The magnitude of the increase in potential exports differs substantially across ECA countries. The currencies of Russia and most countries in Central Asia, South Caucasus and Eastern Europe experienced the largest real deprecia- tion against the renminbi, and thus the estimate of the rise in their potential ex- ports to China is relatively large (figure 2.15). By contrast, the increase in poten- tial exports from countries that experienced a more limited real depreciation with China, for example Western Europe, is relatively small. The change in export potential due to depreciation varies by sector. Producers of manufactures often can respond relatively quickly to increased demand due to exchange rate depreciation, as importers switch to their (now cheaper) products. However, producers of oil and minerals may respond more slowly, given the time required to develop new deposits or to upgrade transport infrastructure. While the speed of the response to changes in demand will vary (producers with excess capac- ity may respond quickly), nevertheless the estimated relationships between price changes and the supply response will tend to be smaller in natural resources than in manufactures.8 For example, the real depreciation of the ruble against the renminbi increases Russia’s potential exports of natural resources to China by 11.6 percent, but Russia’s potential exports of low-skilled manufactures to China by over 19 percent. 46  ●   World Bank ECA Economic Update April 2016 FIGURE 2.15 Exchange rate depreciation could boost ECA’s exports to China (percent change in volume of total exports) 14 Agriculture 12 Percent change 10 8 6 4 2 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 14 Natural resources 12 Percent change 10 8 6 4 2 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 25 Low-skill manufacturing 20 Percent change 15 10 5 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region 20 High-skill manufacturing 18 16 Percent change 14 12 10 8 6 4 2 0 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region Source: based on gravity model with data from UN COMTRADE, United Nations, and Global Economic Monitor, World Bank. Note: The figure shows the percentage change in potential exports from each region in each sector estimated by the gravity model, as a result of the real depreciation experienced from early 2015 to early 2016. See Annex A for more details on the simulation, and regional and sectoral classi- fication. Chapter 2: China’s Impact on Europe and Central Asia ●  47 The depreciation of ECA currencies also opens opportunities for increasing domestic sales of tradable goods. As the price of domestic products declines relative to Chinese products, consumers and firms in ECA will switch from im- ports to domestic production. Russia and countries in Central Asia, South Cau- casus and Eastern Europe experience the largest percentage reductions in poten- tial imports, although the percentage declines in imports of agricultural goods are substantially less than the declines in manufactures. Interestingly, all sub-re- gions except Russia and Central Asia experience a rise in imports of natural resources due to the depreciation. This results from the increased supply of natural resources from Russia and Central Asia (which are major suppliers to other ECA sub-regions), where the real exchange rate depreciation was quite large (figure 2.16). 2.5 How does China’s growth slowdown affect ECA? As discussed in section 2.2, China is experiencing a structural transformation marked by lower productivity growth and a rebalancing of its economy. These transformations in China present the ECA region with both challenges and op- portunities, which differ across countries, sectors, and factors (low-skilled work- ers, high-skilled workers, and capital). This and the next section use a comput- able general equilibrium model (see box 2.2) to calculate the impact on ECA BOX 2.2 Computable general equilibrium model The impact on ECA of changes in China, in this equals the capital stock in period one plus invest- section and the next, is simulated with a comput- ment and minus depreciation in period one. Simi- able general equilibrium model (CGE). The CGE is larly, the labor force in period two equals the labor based on a base year data matrix that traces the force in period one, plus new entrants and minus flows between sectors within each ECA sub-region those retiring. and between ECA sub-regions and abroad. Firms The CGE assumes that markets clear, so that purchase factors (for example labor and capital) the equality of supply and demand determine and intermediate inputs to produce goods and equilibrium prices for factors, goods and ser- services. Payments to factors of production are vices. For example, all workers are employed, so allocated to households (after taxes), and house- that a change in demand for labor is reflected in holds use this income to purchase the goods and changes in the wage rate and not in changes in services produced by firms. The government sec- unemployment. Thus, the results presented in the tor receives all net tax payments and purchases main text do not take into account frictions that goods and services. could increase unemployment or idle machines In each scenario, changes in exogenous vari- as labor and capital shift to new production. The ables, for example productivity growth, are CGE model provides an order of magnitude esti- imposed and the model is solved as a sequence mate of the impact of a slowdown in China once all of comparative static equilibria, where the factors economic actors have completed their adjustment of production are exogenous in each time period to the new equilibrium. The model should not be and linked to the next time period through identi- viewed as providing information on changes in ties. For example, the capital stock in period two economic activity during the adjustment process. Note: For a description of the CGE model used in this chapter, see ENV-Linkages Model, Version X.04, by Dominique van der Mensbrugghe with Jean Chateau, Rob Dellink and Francois Chantret. 48  ●   World Bank ECA Economic Update April 2016 FIGURE 2.16 Exchange rate depreciation has created opportunities to compete with imports (percent change in potential imports as a result of real exchange rate depreciation in ECA) Agriculture 1 0 –1 Percent change –2 –3 –4 –5 –6 –7 –8 –9 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region Natural resources 7 6 5 Percent change 4 3 2 1 0 –1 Central Central Eastern Northern Russian South Southern Turkey Western Western –2 Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe –3 –4 Region High–skill manufacturing 0 –2 Percent change –4 –6 –8 –10 –12 –14 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region Low-skill manufacturing 0 –2 Percent change –4 –6 –8 –10 –12 –14 –16 Central Central Eastern Northern Russian South Southern Turkey Western Western Asia Europe Europe Europe Federation Caucasus Europe Balkans Europe Region Source: Based on gravity model with data from UN COMTRADE, United Nations, and Global Economic Monitor, World Bank. Note: The figure shows the percentage change in potential imports to each region in each sector estimated by the gravity model, as a result of the real depreciation experienced from early 2015 to early 2016. See Annex A for more details on the simulation, and regional and sectoral classification. Chapter 2: China’s Impact on Europe and Central Asia ●  49 countries of slower economic growth in China and of its rebalancing. These changes of the Chinese economy are intended as experiments. They address ‘what if’ questions and should not be considered forecasts of the most likely fu- ture path of the Chinese economy.9 For example, this section compares a business as usual (BaU) scenario with an alternative where GDP growth is 3 percentage points a year lower over a period of 10 years. While, as shown in figure 2.2, po- tential GDP growth in China has probably already decreased by close to 3 per- centage points between 2000–2010 and 2011–2015, the 3 percentage points differ- ence between the BaU and the alternative scenario should not be interpreted as a forecast of a further drop, but simply as a what if question. A reduction of economic growth in China—coming from a deceleration of productivity growth that is uniform across sectors—is transmitted to the world economy as both a decline in import demand from China and a reduction of export supply from China. China’s specialization determines which sectors and countries will be most affected by China’s slower growth in demand and exports. In 2016, China is projected10 to run a large deficit in primary commodities, par- ticularly natural resources where the deficit reaches 38 percent of world trade (figure 2.17). At the same time, China’s net surplus is projected at 12 percent and 5 percent of world trade for low-skilled and high-skilled manufactures, respec- tively. Thus, slower growth in China will tend to reduce demand for the products of countries that specialize in primary commodities, but also reduce the competi- tion faced by countries that specialize in manufactures. In sum, a Chinese econ- omy growing at a slower pace represents a challenge for some sectors or coun- tries, and an opportunity for others. FIGURE 2.17 China imports primary goods and exports manufactures (net surplus as a percent of world trade, 2016 Business as Usual) 20 10 Net surplus as a percent of world trade 0 Agriculture Livestock Oil and gas Natural Low-skilled High-skilled resources manufactures manufactures –10 –20 –30 –40 –50 Source: Author’s calculation based on CGE simulations Note: See Annex B for sectoral classification. 50  ●   World Bank ECA Economic Update April 2016 FIGURE 2.18 China’s slowdown has a mixed impact on ECA’s exports (percentage di erence in export values in slowdown compared to business as usual scenario) 1.5 1 Percentage difference in export volumes 0.5 0 Russian Kazakhsta n Azerba ijan Kyrgyz Ukr aine Pola nd Bulg aria Turkey an d EU and –0.5 Federation Repub lic other ECA EFTA –1 –1.5 –2 –2.5 –3 –3.5 Source: Author’s calculation based on CGE simulations. Note: Percent differences between the two scenarios are calculated in 2025 (i.e. after 10 years of slower growth). See Annex B for regional classification. A slowdown in China would have a significant impact on trade in ECA (figure 2.18). China is an important destination of exports from the eastern part of the region—10 and 24 percent of total exports of Russia and Kazakhstan, re- spectively, go to China—while the western part of the region is less dependent on demand from China. Thus the fall in exports to China would affect the eastern part of ECA more than the west. The fall in China’s demand would particularly hit exporters of primary commodities, mostly from the east. The eastern part of the region is more spe- cialized in the production and exporting of natural resources and agricultural products, and China’s demand for these products would fall sharply relative to the business as usual scenario. The slowdown reduces China’s total import de- mand for oil and gas by about 12 percent, while China’s supply of these products is basically unchanged. A similar demand shock is registered when agricultural products are considered: Chinese demand shrinks by 9 percent, while China’s supply of agricultural products falls by 7 percent. Exporters of agricultural prod- ucts and natural resources can find new markets, or expand market share in ex- isting ones, to substitute for lower demand from China. However, this would require reducing their prices, so the scope for such substitution is limited. Countries in the western part of ECA can benefit from the slowdown in China. Countries such as Poland, Bulgaria, and members of the European Union tend to specialize in high-skilled manufactures. The slowdown reduces China’s imports of these goods by 7 percent, but also reduces China’s exports of these goods by almost 11 percent. The demand for ECA’s exports of high-skilled manu- factures rises in third markets (in the simulation compared to the business as usual scenario), as China’s exports of high-skilled manufactures become rela- Chapter 2: China’s Impact on Europe and Central Asia ●  51 tively more expensive. Overall, exports from countries in the western part of ECA would rise due to the slowdown in China’s GDP. This calculation of the impact on both primary commodity and manufactures exports represents a structural shift in demand, and does not reflect short-term disruptions that could occur (see box 2.2). Countries where export production accounts for a larger share of output and employment will experience a larger impact on their domestic economy, for good or ill, from the slowdown in China. About 13 percent of global production (including intermediate goods) is traded. However, some sectors are more ‘open’ than others. Trade in natural resources (metals, mineral, oil and gas) tends to be quite large relative to sectoral output, as production is concentrated in a limited number of countries; on average a third of global production of natural resources is traded. High-skilled manufacturing (i.e. heavy manufacturing and investment goods) also is quite open, with again almost a third of its production being traded. By comparison, only about 20 percent of total production is traded in low-skill manufacturing sectors (food products, textile and other light manufacturing). Agricultural sectors tend to be even less open, because many countries pursue policies of self-sufficiency in food production and agricultural trade is more dis- torted than trade in other goods. This pattern also can be seen in ECA countries. Countries that specialize in oil and gas may export more than half of that sector’s output. The differences across ECA regions in total export to production ratios are not great, in part because in most countries the share of services that is exported is low compared to other sec- tors, while services tend to account for a large share of production. Nevertheless, countries in the less developed, eastern part of ECA have somewhat higher ratios of exports to production (although Russia is an important exception) than coun- tries in the more developed, western part of ECA (figure 2.19). Thus, the (nega- tive) impact on GDP of China’s slowdown will be slightly greater in the east than the (positive) impact on GDP in the west. FIGURE 2.19 Share of exports in GDP is larger in the east (forecast of 2016 export to GDP ratio at current prices, percent) 40 35 30 25 Percent 20 15 10 5 0 Russian Kazakhsta n Azerba ijan Kyrgyz Ukr aine Pola nd Bulg aria Turkey an d EU and Federation Repub lic other ECA EFTA Region Source: Author’s calculation based on CGE simulations Note: Exports are taken from the national income accounts, and hence include both goods and services. See Annex B for sectoral classification. 52  ●   World Bank ECA Economic Update April 2016 A slowdown in China also would affect the terms of trade of ECA countries. As China’s demand for imports slows, its terms of trade will rise by 2.4 percent (an improvement equal to 0.6 percent of GDP) compared to the business as usual scenario. Terms of trade changes for countries in the western part of ECA would be minimal. Lower demand from China will reduce the prices of oil, gas, and miner- als that these countries import, which would balance some decline in the prices of their manufactured exports as they switch from China to other markets (and the in- crease of prices of Chinese goods still imported by the western countries of ECA)11. Countries in eastern ECA, however, will experience a decline in the price of their oil, gas and minerals exports as China’s demand slows. Lower prices on their exports will result in a real depreciation of the exchange rate in most countries of eastern ECA, while real exchange rate changes will be small in the western part of ECA. China’s deceleration would benefit lower skilled workers versus high- skilled ones, and labor vis-à-vis capital. China specializes in the production of low-skilled manufactured goods, so a slowdown in China’s export growth will increase demand for the goods produced by low-skilled workers in other coun- tries, thus improving their wages relative to high-skilled workers (figure 2.20). At the same time, reduced demand from China for relatively capital-intensive goods such as oil, gas, and minerals, would reduce the return on capital compared to wages, thus benefiting workers in general. As the impact of the slowdown in China on the terms of trade and real exchange rate is larger in the eastern part of ECA than in the west, the impact on factor prices is also greater in the east. In summary, slower growth in China would reduce the growth of demand for ECA’s oil, gas, and mineral exports, which will particularly affect countries in the eastern part of ECA. While China’s demand for the manufactured exports FIGURE 2.20 China’s slowdown improves returns to workers, particularly unskilled workers (percent change in China slowdown versus business as usual scenarios) 0.9 0.8 0.7 0.6 Percent change 0.5 0.4 0.3 0.2 0.1 0 Russia Kazakhstan Azerbaijan Kyrgyz Ukraine Poland Bulgaria Turkey and EU and EFTA -0.1 Republic Other ECA Region Wage/rental rate Unskilled/skilled wages Source: Author’s calculation based on CGE simulations Chapter 2: China’s Impact on Europe and Central Asia ●  53 also will slow, exporters of manufactures will face reduced competition from China in third markets, leading to an overall rise in their exports compared to the business as usual scenario. Slower demand for capital-intensive goods lowers the return on capital compared to wages, while a reduced supply of China’s exports of manufactures increases low-skilled wages relative to high-skilled wages. While the magnitudes are much smaller, this scenario is in a sense a mirror image of the role that China has played over the past thirty years. Rapid growth in China generated substantial benefits for the world economy, increasing the supply of low-cost goods, providing profitable opportunities for investment by foreign firms, and increasing the efficiency of global supply chains. At the same time, China’s entry into global markets had important distributional affects: the rise in the supply of low-skilled manufactures and rapid increase in the demand for capital-intensive products reduced low-skilled wages relative to high-skilled wages, and increased the return on capital relative to wages. Thus, China’s rise made some contribution to increasing inequality in the rest of the world. A pro- ductivity slowdown in China accompanied by rising wages of low-skilled work- ers might dampen consumption growth but would also imply a partial reversal of this distributional impact. 2.6 Rebalancing: shifting opportunities The impact on the global economy of slowing productivity growth in China will depend on the extent of structural change. The scenario in section 2.5 as- sumed a decline in productivity that was uniform across sectors. In this section, we examine the impact of structural changes in China that would boost growth in the face of the erosion of China’s competitive position in low-skilled manufac- tures. While to some extent such changes will arise spontaneously as productiv- ity slows and low-skilled manufacturing production becomes less profitable, policy reform can facilitate this process. As discussed in section 2.2, structural changes required for a rebalancing of China’s economy that will have a significant impact on ECA include a shift from investment to consumption, rising comparative advantage in high-skill manufactures, and increased outward FDI. The following assumptions are im- plemented in the CGE model to reflect the rebalancing scenario: (i) In 2015, investment equaled 42 percent of GDP, compared to 35 percent for consumption (13 percent was government expenditures and the remainder net exports). We assume that the share of investment in GDP will fall by more than 15 percentage points over a period of 10 years, with a corresponding rise in the share of consumption. Slower growth in investment compared to consumption will imply slower growth in demand from China for capital goods, as high-skill manufactures (which are largely capital goods) account for 34.1 percent of invest- ment demand but only 9.5 percent of consumer demand (figure 2.21). Thus, Chi- na’s demand for capital goods imports is likely to decelerate. (ii) Greater investment in education will increase the inflow of skilled workers into the labor force. We assume that the share of skilled workers in China will almost double over the next 10 years, implying an increase of 100 million skilled 54  ●   World Bank ECA Economic Update April 2016 FIGURE 2.21 Lower 40 investment would particularly Expenditures as a share of final demand (%) a ect China’s demand for 35 high-skilled manufactures (expenditures as a share 30 of final demand, 2015) 25 20 Low-skilled manufactures 15 High-skill manufactures 10 5 0 Consumption Investment Source: Author’s calculation based on CGE simulations FIGURE 2.22 Skilled workers in total employment, 30 in China (percent) 25 Total employment (%) 20 Business as usual 15 Rebalancing scenario 10 5 0 Now 5 years 10 years Years Source: Author’s calculation based on CGE simulations workers (figure 2.22). The increasing share of skilled workers will improve China’s comparative advantage in high-skilled manufactures, with important implica- tions for its trade with ECA. (iii) Finally, the simulation includes a rise of China’s FDI outflows equal to 5 percentage points of GDP over the next 10 years. This increase in investment is allocated in proportion to the GDP of countries now receiving FDI from China, with the exception of Central Asia that is receiving larger flows. Higher FDI in- flows will increase the capital stock and therefore growth, finance a greater vol- ume of imports, and lead to an appreciation of the exchange rate, which will in turn change both the trade balance and the composition of trade. The rebalancing scenario has very different effects on ECA countries than the slowdown discussed in section 2.5. Rebalancing would increase household consumption (at constant prices) across the region, while the slowdown scenario would reduce household consumption. The eastern part of the region benefits Chapter 2: China’s Impact on Europe and Central Asia ●  55 FIGURE 2.23 Change in private consumption relative to business as usual scenario (percent) 8 6 5.7 4 3.3 3.0 2 1.8 1.6 1.4 Percent 0 –0.5 –1.0 –1.1 –0.9 2 –1.2 4 –4.7 6 Russian Federation Kazakhstan Azerbaijan Kyrgyz Republic Ukraine EU and EFTA Region Rebalancing Slowdown Source: Author’s calculation based on CGE simulations more than the west due to shifts in China’s comparative advantage in manufac- tures (see below). Higher FDI outflows from China are also likely to boost pro- duction of natural resources in eastern ECA, while reducing opportunities for profit by multinational firms in the more developed west. The impact on private consumption is quite large for some countries in Central Asia. For example, by 2025 household consumption rises in Azerbaijan by almost 6 percent in the rebal- ancing simulation (figure 2.23). By contrast, the increases in household consump- tion in Western Europe are relatively small. The rebalancing scenario has a particularly large impact on trade of high- skill manufactures. Compared to the business as usual scenario, by 2025 China reduces its imports of high-skill manufactures by 21 percent and increases its exports by 9 percent. The increase in exports is due in part to the increased supply of high-skilled workers, and also because China’s increased foreign direct invest- ment outflows raise foreign demand for high-skilled manufacturing, especially by China’s close trading partners.12 The impact on different countries in ECA of changes in China’s demand and supply of high-skilled manufactures depends on both geographic and product specialization. By 2025, for instance, Kazakhstan’s exports to China of high-skilled manufactures are 12 percent lower in the rebalancing scenario com- pared to the business as usual scenario (figure 2.24). While Kazakhstan’s exports of high-skill manufacturing represent only 9 percent of total exports, more than half of them are directed to China. Kazakhstan’s total exports fall by only 1.1 percent. Western Europe’s exports of high-skilled manufactures are only 2.5 per- cent lower in the rebalancing scenario than in the business as usual scenario. While for Western Europe these exports account for 43 percent of the total value, only 7 percent of them are sold to China. Thus Western Europe’s total exports also fall by 1.1 percent. In other words, Western Europe is much more specialized in the production of high-skill manufactures than Kazakhstan (and other Central Asian countries) and so potentially more affected by a drop in demand for these 56  ●   World Bank ECA Economic Update April 2016 FIGURE 2.24 Rebalancing boosts China’s exports of high-skilled manufactures and reduces ECA’s (percentage di erence between rebalancing and business as usual scenarios) 8 8 6 Change in exports (share of total) 4 Exports (percent di erence) 4 0 2 –4 –8 0 –12 –2 China Russian Kazakhstan Azerbaijan Kyrgyz Ukraine Poland Bulgaria EU & EFTA Turkey and Federation Republic other ECA Region Exports of high-skill manufactures as percentage di erence (left axis) Change in exports of high-skill manufactures as share of total (right axis) Source: Author’s calculation based on CGE simulations Note: Percent differences between the two scenarios are calculated in 2025 (i.e. after 10 years of rebalancing). See Annex B for regional classification. goods. But, at the same time, Western Europe is much more diversified in terms of geographic destinations, and thus a Chinese reduction in demand is not as significant. The rebalancing scenario, and specifically the increased share of skilled workers in China, would reduce inequality in the global economy. The entry of about 100 million new skilled workers in China economy affects the premia that educated workers command over unskilled ones. China begins importing a lower amount of skilled intensive products and actually increases its exports of these products to all trading partners. This reduces the wages of skilled (and generally higher income) workers relative to unskilled (and generally lower in- come) workers. The skill premium falls in all country groupings, with the exception of North America (figure 2.25). For some, such as the Kyrgyz Republic, the premia decreases by more than two percentage points.13 This is the result of the expansion of sectors that use more intensively unskilled workers, mainly agriculture and manu- facturing. 14 For similar reasons, the urban premium (the gap between wages of un- skilled workers employed in manufacturing and services versus wages of those em- ployed in agriculture) falls in the rebalancing scenario compared to the business as usual scenario. In other words, the specialization of production towards export- ables and specifically towards agriculture increase demand for unskilled workers whose wages are then bid up (figure 2.26). The shift from investment to con- sumption in China also reduces demand for capital goods (most of which are high-skill manufactures), and thus reduces the return on capital vis-à-vis labor. Chapter 2: China’s Impact on Europe and Central Asia ●  57 FIGURE 2.25 China rebalancing reduces the Rest of the world skill premium globally Major OPEC (percentage di erence in EU and EFTA Turkey and other ECA skill premium between Bulgaria rebalancing and business Poland as usual scenarios) Region Ukraine Kyrgyz Republic Azerbaijan Kazakhstan Russian Federation North Am excl Mex India –2.5 –2.0 –1.5 –1.0 –0.5 0.0 Percentage di erence Source: Author’s calculation based on CGE simulations Note: Percent differences between the two scenarios are calculated in 2025 (in this figure only the change in the share of skilled workers is accounted for, i.e. the increase of consumption and large capital outflows are excluded). See Annex B for regional classification. FIGURE 2.26 China skilling reduces the return on urban Azerbaijan occupations for unskilled India workers (percentage Major OPEC di erence between wages of unskilled in urban versus Kazakhstan rural occupations in Region Ukraine rebalancing versus business Rest of ECA as usual scenarios) Bulgaria Kyrgyz Republic Rest of the world 5 4 3 2 1 0 Percentage di erence Source: Author’s calculation based on CGE simulations Note: Percent differences between the two scenarios are calculated in 2025 (in this figure only the change in the share of skilled workers is accounted for, i.e. the increase of consumption and large capital outflows are excluded). See Annex B for regional classification. 2.7 Conclusions China is important for ECA. ECA’s imports from China have grown rapidly over the past two decades, and China is now ECA countries’ largest import partner outside the region. ECA’s exports to China also have increased, albeit at a lower rate than imports from China. China is also a significant competitor for ECA’s export products in third markets, and has a large influence on the global prices of ECA’s natural resources. Exports from many countries in eastern ECA remain well below the level predicted by the gravity model, indicating considerable po- tential to expand their exports going forward. By contrast, in most countries in 58  ●   World Bank ECA Economic Update April 2016 western ECA, exports are close to or above the level predicted by the gravity model, indicating less potential for expansion. Going forward, changes in China’s large, dynamic economy will offer im- portant opportunities and challenges for ECA economies. The impact of China on individual ECA countries will vary greatly, depending on the structure of each economy. Three scenarios are explored to measure this impact: a real depreciation in ECA currencies, based on the 2015 experience; a productivity slowdown in China; and a rebalancing of the Chinese economy. The principal lessons for ECA from these scenarios include: • All ECA currencies depreciated significantly in real terms against the renmin- bi in 2015, increasing the competitive position of ECA products in China, in third markets, and in ECA’s domestic economies. • A continuing slowdown in productivity in China would erode the competi- tive position of countries in eastern ECA. Slowing demand for their natural resource exports would reduce their export volumes and lower their terms of trade. By contrast, lower productivity growth in China would improve the competitive position of exporters of manufactures, thus benefiting the more developed countries of western ECA. Lower productivity growth in China also would imply shifts in the distribution of income towards wages versus capital and towards low-skilled workers versus high-skilled workers, particu- larly in eastern ECA. • A rebalancing of the Chinese economy towards more rapid growth in con- sumption and efforts to increase production of high-skilled manufactures would tend to benefit eastern ECA more than western ECA. Exports of high- skilled manufactures from more developed countries in western ECA would face greater competition from China, while the demand for low-skilled manu- factures from less developed ECA countries could increase. Reviewing the opportunities and challenges offered by ECA’s economic relationship with China provides important information for policy. Extracting the maximum benefit from, and limiting the adverse effects of, changes in export opportunities due to shifts in China’s comparative advantage requires flexible labor and capital markets. This underlines the importance of policy reforms to improve flexibility. Even with current policies, however, ECA economies have considerable potential to capitalize on these opportunities. Recognizing this po- tential, and understanding the magnitude and direction of changes generated by ECA’s trade relationships with China, can provide important support for the re- forms necessary to improve welfare. Chapter 2: China’s Impact on Europe and Central Asia ●  59 Annex A: Gravity Model Gravity model The gravity model covers 208 countries and territories and spans the period of 1996–2014. Trade data come from the UN Comtrade. The real exchange rates come from the Global Economic Monitoring database. GDP per capita and population are taken from the World Development Indicators database. Following Anderson (2011), the model employs a Poisson Pseudo-Maximum Likelihood (PPML) technique to take into account the many zeros in the data. The estimation equation and results are summarized below. Where Ln(tradeijt) is the trade between origin country i and destination country j at time t. Zi, Zj, and Zt are country and year fixed effects. TABLE A1  Gravity Model Results Natural Low-skill High-skill Agriculture resources manufacturing manufacturing All sectors Ln(real exchange rate) −0.22*** −0.23*** −0.39*** −0.32*** −0.32*** Ln(GDP per capita 2005 USD_origin) −0.27*** 0.35*** −0.02*** 0.62*** 0.40*** Ln(GDP per capita 2005 USD_destination) 1.29*** 1.04*** 0.88*** 0.96*** 0.97*** Ln(Population origin) −1.09*** 0.61*** 0.34*** −0.17*** 0.32*** Ln(Population destination) 1.39*** 0.98*** 1.42*** 0.34*** 0.56*** Ln(distance) −0.69*** −1.02*** −0.56*** −0.54*** −0.54*** Contiguous 0.63*** 0.50*** 0.66*** 0.47*** 0.55*** Colonial link 0.44*** 0.77*** 0.43*** 0.13*** 0.22*** Common language 0.08*** 0.30*** 0.25*** 0.20*** 0.20*** Other Regional Trade Agreement 0.52*** 0.58*** 0.54*** 0.57*** 0.58*** European Union 1.37*** 0.71*** 1.15*** 0.93*** 0.95*** 1 if origin is GATT/WTO member −0.12*** 0.03*** 0.25*** 0.23*** 0.20*** 1 if destination is GATT/WTO member 0.26*** 0.60*** 0.01*** 0.21*** 0.18*** Constant 5.61*** −15.66*** −15.60*** 2.67*** −4.61*** Observations 411,728 301,408 472,639 479,037 486,723 60  ●   World Bank ECA Economic Update April 2016 Simulation of potential export changes based on exchange rate depreciations We calculate the real exchange rate depreciation for each country pair in the sam- ple for the period between January 2015 and February 2016. The expected per- centage change in exports is the product of the real exchange rate elasticity for each sector, estimated from the gravity equation, and the actual real exchange rate change. This expected percentage change in exports is applied to the 2014 bilateral trade flow for each pair of trading partners (the latest trade data avail- able). The results are then aggregated for each country and region. Thus the com- bined effect on exports depends not only on the size of the real exchange rate change but also on the pattern of trade of each country or region, that is, the effect is larger if a country appreciated/depreciated against an important trading part- ner. For example, despite similar levels of real depreciation in Russia and Central Asia against the world as a whole, the expected percentage increase of total ex- ports in Russia is larger than in Central Asia. This is partly explained by the fact that Russia is a major trading partner for the Central Asian economies which did not depreciate vis-à-vis Russia. On the other hand, the Central Asian economies account for a relatively small share of total Russian exports. The expected impact of the real depreciation in ECA on the region’s exports is calculated assuming that all other determinants of trade in the gravity equation remain the same as in 2014. This assumption is unlikely to hold in reality. The large oil price decline, which was one of the drivers of the real depreciations in the Eastern part of the region in the last two years, will likely have important effects on the real economy which could in turn impact trade flows (likely in the opposite direction of the real exchange rate impacts). This simulation therefore reflects only the partial impact of the real exchange rate change on bilateral trade flows. Regional and sectoral classification The gravity model results, when aggregated to the regional groups, use the re- gional classification as shown in table 0.1 on the page xi. TABLE A2  Sectoral classification Sector aggregate Sector Agriculture Paddy rice, Wheat, Cereal grains nec, Vegetables, fruit, nuts, Oil seeds, Sugar cane, sugar beet, Plant-based fibers, Crops nec, Bovine cattle, sheep and goats, horses, Animal products nec, Raw milk, Wool, silk-worm cocoons, Forestry, Fishing Natural resources Coal, Oil, Gas, Minerals nec, Petroleum, coal products Low-skill Bovine meat products, Meat products nec, Vegetable oils and fats, Dairy products, Processed manufacturing rice, Sugar, Food products nec, Beverages and tobacco products , Textiles, Wearing apparel, Leather products, Wood products, Mineral products nec, Ferrous metals, Metals nec, Metal products, Manufactures nec High-skill Paper products, publishing, Chemical, rubber, plastic products, Motor vehicles and parts, manufacturing Transport equipment nec, Electronic equipment, Machinery and equipment nec Source: Sectors are classified according to ISIC Rev. 3. The sector aggregates are classified according to Lakatos et al. (2015). Note: nec=not elsewhere classified Chapter 2: China’s Impact on Europe and Central Asia ●  61 References Anderson, James E. 2011. “The Gravity Model,” Annual Review of Economics 3(1): 133– 160. Lakatos, Csilla, Maryla Maliszewska, and Israel Osorio-Rodarte. 2015. “China’s Slowdown and Rebalancing: Potential Growth and Poverty Impacts on Sub-Saharan Africa.” Mimeo. 62  ●   World Bank ECA Economic Update April 2016 Annex B: Computable General Equilibrium Model Additional Tables This annex provides more detailed information on the initial situation of trade flows and the impact of the slowdown in China as simulated using the CGE model. The following tables illustrate the initial situation in terms of trade flows. The first two tables show the global market share of importers (table B1), of exporters (table B2) by broad category of good and service, i.e. how much each country imports or exports as a share of total world imports and exports. TABLE B1  Global market share by importer and good (%) Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Importer: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade China 22 23 10 39 6 10 6 3 10 India 2 1 6 7 3 2 2 3 3 North Am excl Mex 8 8 16 3 15 17 11 15 15 Russian Federation 2 2 0 1 2 2 2 2 2 Kazakhstan 0 0 0 0 0 0 1 0 0 Azerbaijan 0 0 0 0 0 0 0 0 0 Kyrgyz Republic 0 0 0 0 0 0 0 0 0 Ukraine 0 0 1 1 0 0 0 0 0 Poland 1 2 1 1 1 1 1 1 1 Bulgaria 0 0 0 1 0 0 0 0 0 Turkey and rest of ECA 3 6 4 2 5 5 3 3 4 EU and EFTA 26 30 26 16 34 30 42 45 32 Major OPEC 7 6 3 2 6 5 5 6 5 Rest of the world 29 21 32 29 27 27 26 22 27 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices. TABLE B2  Global Market share by exporter and good (%) Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Exporter: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade China 2 4 2 1 18 16 5 3 11 India 2 1 3 3 3 1 1 4 2 North Am excl Mex 28 19 8 8 9 13 9 20 12 Russian Federation 2 0 12 5 2 1 2 1 3 Kazakhstan 0 0 2 1 0 0 0 0 0 Azerbaijan 0 0 1 0 0 0 0 0 0 Kyrgyz Republic 0 0 0 0 0 0 0 0 0 Ukraine 1 0 0 1 1 0 1 0 0 Poland 0 1 0 0 1 1 1 1 1 Bulgaria 0 0 0 0 0 0 0 0 0 Turkey and rest of ECA 4 6 2 1 5 4 5 3 4 EU and EFTA 18 34 13 7 30 33 41 48 31 Major Opec 3 2 33 11 3 2 4 3 7 Rest of the world 39 33 24 60 27 29 29 18 28 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices Chapter 2: China’s Impact on Europe and Central Asia ●  63 The next two tables show the importance of trading partners from the point of view of China, i.e. how much China imports from a specific country as a percent- age of its total imports (table B3); and likewise on the export side (table B4). TABLE B3  Chinese imports by source and good (%) Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Exporter: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade India 3 0 0 7 3 1 3 8 2 North Am excl Mex 40 25 1 4 11 11 5 20 11 Russian Federation 3 0 11 3 3 1 1 1 3 Kazakhstan 0 0 4 1 2 0 0 0 1 Azerbaijan 0 0 0 0 0 0 0 0 0 Kyrgyz Republic 0 0 0 0 0 0 0 0 0 Ukraine 0 0 0 1 0 0 0 0 0 Poland 0 0 0 0 0 0 0 0 0 Bulgaria 0 0 0 0 0 0 0 0 0 Turkey and rest of ECA 1 1 4 1 1 1 3 3 2 EU and EFTA 1 17 1 2 15 19 27 30 14 Major Opec 1 0 32 11 4 3 5 8 8 Rest of the world 51 56 46 70 61 63 56 31 59 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices TABLE B4  Chinese exports by destination and good (%) Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Importer: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade India 3 1 7 5 2 4 2 3 3 North Am excl Mex 6 14 3 9 24 26 11 20 24 Russian Federation 6 1 2 1 3 2 3 2 2 Kazakhstan 1 0 2 0 1 0 1 0 1 Azerbaijan 0 0 0 0 0 0 0 0 0 Kyrgyz Republic 0 0 0 0 1 0 0 0 0 Ukraine 0 0 0 0 0 0 0 0 0 Poland 0 2 0 1 1 1 0 0 1 Bulgaria 0 0 0 0 0 0 0 0 0 Turkey and rest of ECA 1 2 1 2 2 4 2 2 3 EU and EFTA 10 34 7 13 21 18 33 28 20 Major Opec 12 2 8 3 6 6 7 11 6 Rest of the world 60 43 70 65 39 39 40 34 40 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices 64  ●   World Bank ECA Economic Update April 2016 The next two tables show the importance of China as a source of imports (table B5) or as a destination of exports (table B6) from the point of view of the various trading partners. TABLE B5  Imports from China as a percent share of imports from all countries Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Exporter: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade India 2 4 2 1 15 33 6 3 13 North Am excl Mex 1 7 0 4 28 24 5 3 18 Russian Federation 4 1 17 2 25 16 7 3 15 Kazakhstan 10 1 27 2 54 26 6 2 25 Azerbaijan 0 0 1 5 9 8 6 2 7 Kyrgyz Republic 11 12 2 0 78 34 5 2 53 Ukraine 2 1 0 1 19 13 4 2 9 Poland 1 6 1 2 10 9 1 0 7 Bulgaria 1 1 0 0 4 7 5 1 4 Turkey and rest of ECA 1 1 0 1 8 12 2 2 8 EU and EFTA 1 4 1 1 11 9 4 2 7 Major Opec 3 1 6 2 19 19 7 5 15 Rest of the world 3 8 4 3 26 23 8 4 17 World 2 4 2 1 18 16 5 3 11 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices TABLE B6  Exports to China as a percent share of exports to all countries Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Exporter: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade India 30 8 0 78 5 5 12 7 8 North Am excl Mex 31 31 1 19 8 9 4 3 9 Russian Federation 27 11 9 24 11 12 3 2 10 Kazakhstan 2 26 22 34 26 46 2 2 24 Azerbaijan 1 0 0 70 0 11 1 2 1 Kyrgyz Rep 1 46 25 41 6 2 3 2 5 Ukraine 1 1 0 43 1 2 3 3 5 Poland 0 3 0 2 2 1 0 0 1 Bulgaria 0 0 0 10 3 1 3 3 2 Turkey and rest of ECA 6 2 23 39 1 3 4 4 4 EU and EFTA 1 12 0 8 3 6 4 2 4 Major Opec 5 4 10 39 6 16 8 8 11 Rest of the world 29 39 19 45 14 23 12 6 20 World 22 23 10 39 6 10 6 3 10 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices Chapter 2: China’s Impact on Europe and Central Asia ●  65 The next table shows the surplus or deficit of major trading partners, by sector. TABLE B7  Trade surplus (+) or deficit (-) as % of world trade Oil Gas and Natural Low-skill High-skill Low-skill High-skill Total Trader: Agriculture Livestock Refined oil resources Manuf Manuf Services Services Trade China -20 -19 -8 -38 12 5 -1 -1 2 India 0 -1 -3 -4 0 -1 0 1 -1 North Am excl Mex 20 11 -8 5 -6 -4 -2 4 -3 Russian Federation 0 -1 12 4 0 -2 0 -1 1 Kazakhstan 0 0 2 1 0 0 0 0 0 Azerbaijan 0 0 1 0 0 0 0 0 0 Kyrgyz Republic 0 0 0 0 0 0 0 0 0 Ukraine 1 0 -1 1 0 0 0 0 0 Poland 0 0 -1 -1 0 0 0 0 0 Bulgaria 0 0 0 -1 0 0 0 0 0 Turkey and rest of ECA 1 -1 -3 -1 0 0 2 0 0 EU and EFTA -8 3 -14 -8 -4 3 0 3 -1 Major Opec -4 -4 30 10 -2 -2 -2 -3 2 Rest of the world 10 12 -8 32 0 1 4 -3 1 Source: 2011 GTAP data, projected using the CGE model to 2016; percentages calculated using current prices The next two tables show the difference between trade flows between the business as usual scenario and the China slowdown scenario, for total trade and high-skilled manufactures. TABLE B8  Trade flows in current prices, % difference China slowdown versus BaU, total trade Exporter chn ind oea rus kaz aze kgz ukr pol bgr xec eur opc row wld importer chn 0 -9 -8 -10 -10 -10 -10 -10 -9 -9 -10 -8 -10 -8 -8.4 ind -9 0 1 2 2 -1 1 1 1 2 1 1 1 1 -0.4 oea -9 1 1 1 2 0 1 1 1 1 1 1 1 2 -0.4 rus -9 1 0 0 1 1 0 1 0 0 0 0 1 1 -0.8 kaz -8 1 1 3 0 2 1 3 1 0 0 0 1 1 -1.3 aze -10 0 0 1 1 0 0 0 0 0 0 0 1 0 -0.6 kgz -3 4 3 4 4 8 0 7 0 3 2 1 4 4 0.1 ukr -9 1 0 1 2 0 1 0 1 1 0 1 2 1 0.0 pol -10 1 1 0 2 2 2 1 0 0 1 1 2 2 0.1 bgr -10 1 0 0 1 0 1 0 0 0 0 0 1 1 0.0 xec -10 0 0 0 2 0 1 1 0 0 1 1 1 1 0.0 eur -10 0 0 0 2 0 0 0 0 0 1 1 1 1 -0.1 opc -10 0 0 1 1 -1 0 0 0 0 0 0 1 1 -0.8 row -9 0 1 0 1 -1 1 1 0 0 1 1 0 2 -0.7 wld -9.3 -0.4 0.0 -0.5 -1.0 -0.3 -0.3 0.2 0.3 0.1 0.1 0.3 -0.5 -0.5 -1.2 Source: Global CGE model simulations; Percent differences between the two scenarios are calculated in 2016. 66  ●   World Bank ECA Economic Update April 2016 TABLE B9  Trade flows in current prices, % difference China slowdown versus BaU, high-skill manufacturing Exporter chn ind oea rus kaz aze kgz ukr pol bgr xec eur opc row wld importer chn 0 -7 -7 -6 -5 -6 -7 -7 -8 -7 -8 -7 -6 -7 -6.8 ind -10 0 3 5 5 5 3 3 3 3 3 3 5 4 -0.9 oea -11 2 2 4 4 4 2 2 2 2 2 2 4 3 -0.5 rus -9 1 1 0 2 2 1 1 0 1 1 1 2 1 -0.8 kaz -11 2 2 3 0 3 2 2 2 2 2 2 4 3 -1.1 aze -12 0 0 2 2 0 0 1 0 0 0 0 2 1 -0.4 kgz -7 5 5 6 6 6 0 5 4 5 4 5 6 5 0.9 ukr -10 1 1 3 3 2 1 0 1 1 1 1 3 2 0.1 pol -11 1 1 2 3 2 0 1 0 1 1 1 3 2 0.1 bgr -11 1 1 2 3 2 0 1 1 0 1 1 3 2 0.1 xec -11 1 1 3 3 3 1 2 1 1 1 2 3 2 0.1 eur -11 1 1 2 3 2 1 1 1 1 1 1 3 2 0.0 opc -11 1 1 3 3 2 1 1 1 1 1 1 3 2 -0.9 row -11 2 2 3 4 3 2 2 2 2 2 2 4 3 -0.6 wld -10.6 1.1 0.9 1.9 -0.7 1.7 1.2 1.1 0.7 1.1 0.7 0.9 1.9 0.4 -1.0 Source: Global CGE model simulations; Percent differences between the two scenarios are calculated in 2016. Chapter 2: China’s Impact on Europe and Central Asia ●  67 Computable General Equilibrium Regional and sectoral definitions The tables below show the country or regions and sector or good that are used in the global CGE model simulations. The data for this country-region and sector- good aggregations comes from the GTAP dataset. TABLE B10  Regional aggregation Model Country or Region group code Model Country or Region group name Countries members of group chn China   ind India oea North Am excl Mex, including: Canada United States of America rus Russian Federation kaz Kazakhstan aze Azerbaijan kgz Kyrgyz Rep ukr Ukraine pol Poland bgr Bulgaria xec Turkey and Rest of ECA, including: Turkey Czech Republic Hungary Slovakia Slovenia Albania Belarus Croatia Romania Rest of Eastern Europe Rest of Europe Rest of Former Soviet Union Armenia Georgia eur EU and EFTA, including: Austria Belgium Cyprus Denmark Estonia Finland France Germany (Continued next page) 68  ●   World Bank ECA Economic Update April 2016 TABLE B10 (continued) Model Country or Region group code Model Country or Region group name Countries members of group Greece Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Portugal Spain Sweden United Kingdom Switzerland Norway Rest of EFTA opc Major Opec, including: Indonesia Ecuador Venezuela Iran Islamic Republic of Kuwait Qatar Saudi Arabia United Arab Emirates Nigeria row Rest of the world All remaining countries TABLE B11  Sectoral aggregation Model aggregated sectors/goods GTAP individual sectors/goods Agriculture Paddy rice Wheat Cereal grains, n.e.s. Vegetables and fruits Oil seeds Sugar cane and sugar beet Plant-based fibers Crops, n.e.s. Bovine cattle, sheep and goats, horses Animal products n.e.s. Raw milk Wool, silk-worm cocoons Forestry (Continued next page) Chapter 2: China’s Impact on Europe and Central Asia ●  69 TABLE B11 (continued) Model aggregated sectors/goods GTAP individual sectors/goods Fishing Natural Resources Coal Minerals n.e.s. Oil and Gas Oil Gas Petroleum, coal products Low-skill manufacturing Bovine cattle, sheep and goat, horse meat products Meat products n.e.s. Vegetable oils and fats Dairy products Processed rice Sugar Food products n.e.s. Beverages and tobacco products Textiles Wearing apparel Leather products Wood products Paper products, publishing High-skill manufacturing Chemical, rubber, plastic products Mineral products n.e.s. Ferrous metals Metals n.e.s. Metal products Motor vehicles and parts Transport equipment n.e.s. Electronic equipment Machinery and equipment n.e.s. Manufactures n.e.s. Low-skill Services Electricity Gas manufacture, distribution Water Construction Trade Transport n.e.s. Sea transport Air transport High-skill Services Communication Financial services n.e.s. Insurance Business services n.e.s. Recreation and other services Public administration and defence, education, health services Dwellings 70  ●   World Bank ECA Economic Update April 2016 Notes 1. Potential GDP is estimated using a standard production function approach. Labor inputs are obtained from employment data; physical capital stock is estimated using a perma- nent inventory method. Total factor productivity is a residual; i.e. it is the difference be- tween observed GDP and GDP levels predicted by the production function. The cyclical component of this residual total factor productivity is filtered out, and ‘trend’ total factor productivity is obtained. This trend total factor productivity is added to the primary fac- tors and potential GDP is thus estimated. 2. It is typical that in fast growing developing countries prices are growing faster than prices in slower growing, more advanced countries (all expressed in the same currency). This Balassa-Samuelson effect is caused by a large differential across countries in productivity growth in the tradable sectors, while that differential is smaller for non-tradable sectors. 3. On the relationship between Central Asia and Russia, see Laruelle, Marlene. 2009. “Rus- sia in Central Asia: Old History, New Challenges” EU-Central Asia Monitoring. http:// www.isn.ethz.ch/Digital-Library/Articles/Detail/?id=172418 4. See Annex B for a regional disaggregation of the model. 5. The trade data are reported in terms of total sales rather than value added, and China is an important center for the re-export of manufactured goods. Thus, the large volume of Germany’s manufactured imports from China does not necessarily reflect the structure of China’s domestic production. 6. Tinbergen, Jan. 1962. Shaping the World Economy: Suggestions for an International Eco- nomic Policy. New York: Twentieth Century Fund. 7. The export response is calculated by multiplying the real exchange rate elasticity for each sector, estimated from the gravity model, to the actual real exchange rate change between 1/2015 and 2/2016. The effect on exports does not take into account the impact of the real exchange rate change on other model variables such as GDP. 8. The gravity model does not account for the fact that natural resources are often traded in international currency (US dollars), and thus may overestimate the impact of real ex- change rate change on the exports natural resources. 9. In fact, some analysts think that a scenario where both slower growth and rebalancing happen at the same time is more likely than a scenario with just one of these two chang- es. However, the analysis presents the results of slower growth separately from that of rebalancing to facilitate the identification of the channel of transmission and the mea- surement of their magnitudes. 10. The most recent base year for the database of the Global Trade Analysis Project (www.gtap. agecon.purdue.edu) which is used in the CGE model is 2011. Therefore the model is used to predict the values of imports and exports for 2016 reported in the text. The quantitative results and comments will not be different if one had used the observed data for 2015. 11. It would be possible to break down the analysis of the impact of a slowdown in China further and consider the cost and benefits for consumers and producers separately. For example, the term of trade increase associated to a slowdown in China, as discussed in the text, means that price of Chines goods exported will increase. This has negative im- pact on consumers in countries importing these goods, even if it allows producers in these same countries to become more competitive and increase their sales. 12. The shift in China from investment towards consumption would, by itself, reduce ex- ports of capital goods from China. 13. Note that in China, not shown in the table, the skill premium is reduced by about 50%. 14. In North America agriculture tends to be skill intensive and its expansion (due to an in- crease in demand by China) increases the skill premium. Note that in all countries high- skilled services is one of the largest employer and, by far, the one with the highest skill intensity in production. PART II Country Pages Country Pages ●  73 first and second quarter of 2015, but de- ALBANIA Recent developments creased in the second half of the year fol- lowing the crisis in Greece and tighter capital controls in the banking system. Albania’s economy continued to recover Albania large errors and omissions ac- in 2015, supported by robust private in- counts fluctuated symmetrically to re- Table 1 2015 vestment. Growth is estimated to have mittance flows, suggesting that transfers Population, million 2.9 reached 2.6 percent, with gross fixed capi- made their way to Albania through alter- GDP, current US$ billion 11.7 tal formation contributing 2.2 percentage native means. As such, impacts on house- GDP per capita, current US$ 4030 points to the economic expansion. The hold income are expected to be small. Net large contribution reflected investment in FDI inflows financed about 70 percent of Poverty rate ($2.5/day 2005PPP terms)a 6.7 the Trans Adriatic Pipeline and a hydro- the current account deficit. The Eurobond Poverty rate ($5/day 2005PPP terms)a 47.5 power plant in Southern Albania. Con- issuance of 450 million EUR in early No- a Gini Coefficient 29.0 sumption contributed negatively to GDP vember complemented the external fi- b Life Expectancy at birth, years 77.4 growth in 2015, but there were signs of a nancing and let to an increase in interna- Sources: World Bank WDI and M acro Poverty Outlook. recovery towards the end of the year. Fis- tional reserves, which exceeded five Notes: cal consolidation continued to take place months of imports at yearend. (a) M ost recent value (2012) (b) M ost recent WDI value (2013) in 2015, limiting the Government contri- Labor markets have improved steadily, bution to GDP growth. The budget deficit with a slightly higher employment rate in is estimated to have reached 4.8 percent of the third quarter of 2015 compared to the GDP in 2015, down from 5.9 percent in same period in 2014. This is led by em- 2014. This deficit included arrears clear- ployment expansion in construction, man- The Albanian economy accelerated in ance of 1.3 percent of GDP. While reve- ufacturing, mining, and non-market ser- nues collection underperformed, a spike vices. Agricultural employment declined 2015, and is expected to continue recover- in non-tax revenues, interest savings, and somewhat in the third quarter of 2015, ing over the next three years. Private in- an across-the-board under-execution of after increasing earlier in the year. Growth vestment in large infrastructure projects expenditure kept the overall budget in in employment rate (1.9 pps) was partially and improvements in business climate are line with expectations. Finally, net exports offset by an increase in the labor force par- contributed positively to growth. Unfa- ticipation, leading to modest decline of 0.4 expected to support this expansion. Reig- vorable international oil and mineral pric- pps in unemployment (to 17.1 in 2015). nited job creation will support a gradual es contribute to a weak performance of The employment rate has slightly im- recovery in private consumption. Fiscal real exports, which was more than com- proved for men while remaining stagnant consolidation, which has fallen largely on pensate by a larger drop in real imports. for women. Women are increasingly par- expenditures, will limit the overall contri- The current account deficit is estimated to ticipating in the labor market, but facing have narrowed in 2015, despite the high increasing rates of unemployment. Youth bution of the public sector to growth. volatility in remittance flows. A one -off unemployment (15-29 years) declined with Stronger economic activity and job crea- reduction in net imports of electricity, respect to the previous year, but remained tion are expected to lift living standards and a stronger than expected perfor- high at 32.3 percent. and support gradual poverty reduction. mance in tourism helped narrow the Poverty is expected to continue on a slow trade deficit. Remittances climbed in the decline, as economic growth translates FIGURE 1 Albania / GDP growth decomposition FIGURE 2 Albania / Actual and projected poverty rates and GDP per capita 8.0 Poverty Rate (%) GDP per capita 6.0 70 12,000 4.0 60 10,000 2.0 50 8,000 0.0 40 6,000 -2.0 30 4,000 20 -4.0 10 2,000 -6.0 2010 2011 2012 2013 2014 2015 2016 2017 0 0 Private consumption Government consumption 2002 2004 2006 2008 2010 2012 2014 2016 2018 Gross fixed investment Exports of goods and services $2.5/day PPP $5/day PPP Imports of goods and services GDP per capita PPP Sources: INSTAT and World Bank forecasts. Sources: World Bank (see notes to Table 2). MPO 38 Apr 16 74  ●   World Bank ECA Economic Update April 2016 into job creation. The expected decline These, in turn, will be supported by im- comes on the heels of an increase in pov- erty from 2008 to 2012, when poverty in- provements in the business climate and a pickup in lending as a result of reforms to Risks and challenges creased to 47.5 percent in 2012 from 45.2 address high NPLs. Continued fiscal con- percent in 2008 ($5/day PPP). Poverty is solidation will limit the direct contribution Even if employment has increased, labor estimated to have moderately declined to from the government. All in all, growth is markets remain weak limiting the potential 46.7 percent in 2014 with progress hin- likely to strengthen to 3.2 percent in 2016 of the Albanian economy. A high rate of dered by weakening of labor markets in and 3.5 percent in 2017. informality in employment in Albania ham- the past years with increases in the unem- Poverty is expected to continue its slow pers productivity, tax revenue collections, ployment rate. Nevertheless, labor mar- downward trend. The gradual accelera- and regulatory compliance. Increasing activ- kets are slowly picking up, particularly in tion of the economic and modest improve- ity rates and lowering unemployment, as sectors in which poorer individuals are ments in the labor market will likely drive well as improving the quality of employ- often employed, including agriculture the changes in poverty, given persistently ment, are enduring challenges to lifting liv- and construction. The unemployment low remittances inflows and no significant ing standards. rate for the working age population de- changes in social protection benefits. The Moving forward, Albania faces the chal- clined slightly in 2015, despite an in- downward trend is expected to gradually lenge of finding sustainable sources of crease in the labor force participation continue with poverty at 45.5 percent in growth while ensuring that the poor and rate. Given the gradual labor market im- 2016 and 44.8 percent in 2017. vulnerable are adequately protected. In provements this year, moderate poverty Growth prospects for Albania rely on the this context, it is critical to maintain the ($5/day, 2005 PPP) is expected to stand at continued implementation of structural structural reform momentum and fiscal 46.2 percent in 2015. reforms, with an upside potential if these consolidation efforts. Priority areas in- are accelerated. Reforms in progress – in clude, addressing high NPLs and weak energy, investment management, and business climate, strengthening tax admin- Outlook pensions - are expected to both promote growth and have positive distributional istration and closing loopholes, additional reforms in the energy sector, strengthening effects. New pensions indexation rules public investment management, and miti- The Albanian economy is expected to ac- and the introduction of a social pension, gating fiscal risks. As fiscal consolidation celerate gradually in the medium term. as well as the focus on compensating efforts progress, it is critical to maintain a Stronger growth is projected on the basis changes to energy tariffs through the ex- distributional impact lens to reforms. of a pickup in investment in large FDI- isting social assistance program, are aimed financed infrastructure projects, a recov- at protecting the real incomes of the poor ery of consumption, and buoyant exports. and less well-off. TABLE 2 Albania / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 1.1 2.0 2.6 3.2 3.5 3.8 Private Consumption 1.5 3.6 -3.6 3.2 2.1 2.3 Government Consumption 2.9 2.3 0.9 0.5 -0.1 0.7 Gross Fixed Capital Investment -4.6 -3.1 10.7 13.6 10.5 7.5 Exports, Goods and Services 8.1 0.6 3.2 5.3 6.3 6.3 Imports, Goods and Services 2.5 1.6 -1.6 4.0 2.5 2.2 Real GDP growth, at constant factor prices 1.4 2.2 2.5 3.2 3.5 3.8 Agriculture 0.7 2.2 0.8 3.0 3.2 3.0 Industry 4.9 -2.7 6.3 1.1 4.2 5.0 Services 0.3 4.3 1.6 4.1 3.4 3.6 Inflation (Consumer Price Index) 1.9 1.6 1.8 2.3 2.7 3.0 Current Account Balance (% of GDP) -10.7 -12.8 -6.7 -4.1 -7.1 -8.5 Financial and Capital Account (% of GDP) 7.6 10.1 4.1 1.6 4.7 6.2 Net Foreign Direct Investment (% of GDP) 9.6 8.2 7.0 7.9 7.7 7.1 Fiscal Balance (% of GDP) -5.0 -5.9 -4.8 -2.5 -1.6 -0.7 Debt (% of GDP) 70.1 71.8 71.9 70.7 68.1 64.4 Primary Balance (% of GDP) -1.7 -3.1 -2.2 0.3 1.3 2.2 Poverty rate ($2.5/day PPP terms) a,b,c 6.6 6.4 6.1 5.9 5.6 5.3 Poverty rate ($5/day PPP terms) a,b,c 47.2 46.7 46.2 45.5 44.8 44.0 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2002-LSM S and 201 2-LSM S. (b) P ro jectio n using annualized elasticity (2002-2012) with pass-thro ugh = 1based o n GDP per capita co nstant P P P . (c) P ro jectio ns are fro m 2013 to 2018. MPO 39 Apr 16 Country Pages ●  75 Central Bank to cut policy rates in steps. ARMENIA Recent developments However, monetary conditions remained tight with negative credit growth. The current account deficit narrowed to an Growth slowed slightly to 3 percent in estimated 3.2 percent of GDP in 2015 from 2015 from 3.5 percent in 2014, despite the 7.3 percent in 2014, due to the significant Table 1 2015 spillover from Russia and the fall in the reduction in the trade deficit, which more Population, million 3.0 prices of base metals, Armenia’s main than compensated for the 36 percent fall in GDP, current US$ billion 10.6 export commodities. Output expansion remittances (in US dollar terms). The im- GDP per capita, current US$ 3501 was driven by a good agriculture harvest, proved trade balance was the result of the Poverty rate ($2.5/day 2005PPP terms)a 26.3 the opening of a new copper mine, and a exchange rate adjustment and a sharp im- a fiscal stimulus. Growth of services and port contraction, reflecting soft domestic Poverty rate ($5/day 2005PPP terms) 75.9 manufacturing suffered due to the soften- demand and low international energy and Gini Coefficient a 31.5 ing demand driven by the sharp fall in food prices. Exports performed better than Life Expectancy at birth, yearsb 74.4 remittances. expected, as declining exports to Russia Sources: World Bank WDI and M acro Poverty Outlook. The fiscal position deteriorated significant- were largely offset by rising exports to Notes: ly, reflecting slowing economic activity in China and the Middle East. On the back of (a) M ost recent value (2014) (b) M ost recent WDI value (2013) tax-generating sectors and the fiscal stimu- improved external accounts, pressures on lus, comprising tax relief and increased the dram eased; the Central Bank reduced spending on infrastructure investment, forex intervention sharply in the second social protection, public sector wages, and half of the year, leading to an increase in subsidized lending. Following the decision official reserves to US$1.8 billion at end- to raise electricity tariffs in June, the gov- 2015 from US$1.4 billion in January 2015. As external conditions deteriorated, Ar- ernment, under intense public pressures, Vulnerabilities in the banking sector inten- agreed to temporarily compensate house- sified, and the share of nonperforming menia’s economic activity slowed in 2015, holds and SMEs for the tariff increase (0.1 loans increased from 3.7 percent in early but performed better than initially ex- percent of GDP). The resulting fiscal defi- 2015 to more than 9 percent in late 2015. In pected. The fiscal deficit widened sharply, cit, estimated at 4.9 percent of GDP the context of high dollarization, currency driven by the weak revenue collection, (compared with 2 percent in 2014), was mismatches on banks’ balance sheets pose compounded by the introduction of a fis- financed mainly by external borrowing, risks to the sector’s stability and profitabil- including Eurobonds and budget support ity, prompting the Central Bank to raise cal stimulus . The economy is expected to from the World Bank, leading to a build- the minimum capital requirement during recover modestly over the medium term as up of government debt to about 50 percent the year. global economic conditions improve grad- of GDP at end-2015. Falling remittances and weak domestic ually. However, growth prospects are Inflation has been declining since mid- labor market conditions slowed progress 2015, with the dissipation of the pass- on poverty reduction. The poverty rate shadowed by the slow progress on struc- through effect of the dram’s depreciation (measured at US$2.5/day) fell from 26.3 tural reform agenda, hindering job crea- in late 2014. As domestic demand weak- percent in 2014 to an estimated 25.6 per- tion and poverty reduction. ened further, inflation declined to -0.2 per- cent in 2015. Lower remittance inflows cent (y/y) in December 2015, allowing the have translated into welfare losses for all FIGURE 1 Armenia / GDP growth by sector, 2010-2016 FIGURE 2 Armenia / Actual and estimated poverty rates and GDP per capita (PPP) Growth rate Poverty Rate (%) GDP per capita (USD PPP) (%) 100 9,000 3 90 8,000 2 80 7,000 70 6,000 1 60 5,000 0 50 4,000 40 -1 3,000 30 20 2,000 -2 10 1,000 -3 0 0 2010 2011 2012 2013 2014 2015 2016f 2001 2003 2005 2007 2009 2011 2013 2015 2017 $2.5/day PPP $5/day PPP Industry Agriculture Construction Services GDP per capita PPP Sources: Armenia Statistical Service. Sources: World Bank (see notes to Table 2). MPO 40 Apr 16 76  ●   World Bank ECA Economic Update April 2016 households. Despite strong agricultural time, as the stimulus measures are external environment, including a worsen- growth, the domestic labor market dete- phased out and an economic recovery ing recession in Russia the slow recovery riorated due to limited job creation in boosts revenue collection. of base metal prices, represent significant other sectors compounded by the large - Poverty reduction and income growth risks to Armenia’s prospects for economic scale return of migrant workers from across all levels of the welfare distribution growth and job creation. Furthermore, Russia. The unemployment rate rose are likely to stagnate during 2017-18. Even recent reshuffling in the government per- from 17.5 percent in Q3 2014 to 18.2 under an optimistic scenario—the agricul- sonnel and political developments slated percent in Q3 2015. tural sector continues to perform well and for 2017-18 (Parliamentary and Presiden- remittance inflows recover—without sub- tial elections) could delay the implementa- stantial improvements in the business tion of structural reforms necessary to Outlook environment and the domestic labor mar- ket the poverty rate is projected to fall improve the business environment, there- by hindering productivity growth over only gradually to 23.8 percent in 2018. The the medium term. Growth is projected to slow to 1.9 percent elimination of temporary electricity subsi- As public debt continues to rise, the gov- in 2016, on the back of continued weak- dies, scheduled in August 2016, would ernment has to consolidate fiscal position, nesses in the external conditions and fiscal negatively affect poor households, whose while protecting critical expenditures in tightening. With the recovery of the global expenditure of electricity amounts to more areas such as social assistance and public economy, including metal prices, Arme- than 5 percent of total consumption. investment. Persistently low capital out- nia’s growth is expected to pick up over lays, which bore the brunt of expenditure the medium term, but only moderately to compression in recent years, and low exe- about 3 percent a year, hampered by Risks and challenges cution rates of public investment could structural weaknesses. limit Armenia’s medium-term growth. The budget deficit is projected to remain Armenia’s fiscal sustainability could be wide in 2016, at 3.9 percent of GDP, de- Armenia’s economic outlook is subject to also threatened by the deteriorating finan- spite fiscal tightening through a combina- considerable downside risks. Sustaining cial performance of the energy sector. tion of revenue raising measures and growth in a difficult external environment moderate expenditure cuts. The fiscal with limited fiscal space is a serious policy position is expected to improve over challenge. Further deterioration of the TABLE 2 Armenia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 3.3 3.5 3.0 1.9 2.8 2.9 Private Consumption 0.9 0.5 -4.1 1.3 2.2 2.6 Government Consumption 7.0 6.7 -4.8 -6.3 4.6 4.3 Gross Fixed Capital Investment -7.0 -2.4 0.5 0.8 1.6 1.4 Exports, Goods and Services 8.6 6.4 -1.0 3.2 4.3 5.2 Imports, Goods and Services -2.1 -1.0 -17.3 1.2 2.3 3.6 Real GDP growth, at constant factor prices 3.2 3.7 4.0 1.8 2.8 3.0 Agriculture 7.6 7.8 11.4 3.2 3.6 3.8 Industry 0.5 -2.2 2.6 1.9 3.3 4.1 Services 2.4 5.9 -0.9 0.3 1.4 1.1 Inflation (Consumer Price Index) 5.8 3.0 3.7 3.5 4.0 4.0 Current Account Balance (% of GDP) -7.6 -7.3 -3.2 -3.3 -3.5 -4.0 Financial and Capital Account (% of GDP) 10.3 7.9 3.8 4.0 4.1 4.7 Net Foreign Direct Investment (% of GDP) 3.2 3.3 3.2 3.8 4.2 4.7 Fiscal Balance (% of GDP) -1.6 -2.0 -4.9 -3.9 -2.4 -1.3 Debt (% of GDP) 40.9 43.7 49.3 52.2 51.5 50.4 Primary Balance (% of GDP) -0.6 -0.7 -3.2 -2.0 -0.5 0.2 Poverty rate ($2.5/day PPP terms) a,b,c 30.2 26.3 25.6 25.2 24.5 23.8 Poverty rate ($5/day PPP terms) a,b,c 78.4 75.9 75.1 74.6 73.8 73.0 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 1-ILCS and 2014-ILCS. (b) P ro jectio n using po int-to -po int elasticity (2011-2014) with pass-thro ugh = 0.7 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 3, 2014. P ro jectio ns are fro m 201 5 to 2018. MPO 41 Apr 16 Country Pages ●  77 throughout the year. The quality of AZERBAIJAN Recent developments banks’ asset portfolios deteriorated, and non-performing loans (NPLs) rose sharply as growth fell and servicing for- The overall economy grew by 1.1 per- eign currency -denominated loans be- cent in 2015, compared with 2.8 percent came more costly. The authorities with- in 2014. The sharp fall in oil prices con- drew the licenses of eight banks and Table 1 2015 tinued to weigh on Azerbaijan’s oil - injected large amounts of liquidity to Population, million 9.6 reliant economy. The non -oil sector per- recapitalize the International Bank of GDP, current US$ billion 53.1 formed strongly in the first half of 2015, Azerbaijan, which had 37 percent of the GDP per capita, current US$ 5512 fueled by large government investment. country’s banking assets in 2014. The School enrollment, primary (% gross)a 98.0 However, it decelerated markedly in the economy’s supply of credit contracted 7 Life Expectancy at birth, yearsa 70.6 latter half of the year as the government percent in 2015. cut back capital outlays, leading to a Due to the devaluation’s pass-through Sources: World Bank WDI and Macro Poverty Outlook. decline of over 13 percent in the con- effect, inflation accelerated to 7.7 percent Notes: struction sector, the country’s main non - (year-on-year) in December 2015, up from (a) Most recent WDI value (2013). oil growth driver. 1.5 percent a year earlier. Despite the cred- Faced with falling oil exports and cur- it contraction, policy rates were raised in rency depreciation of key trading - steps to curb pressures on the manat. partner countries, the authorities deval- The consolidated fiscal deficit—the central ued the manat in February 2015 and government, the Nakhchivan autonomous continued to intervene in the market region, the State Oil Fund, and the Social Azerbaijan’s growth slowed in the latter before shifting to a managed float ex- Protection Fund—widened from 0.4 per- half of 2015, affected by the continued change rate regime in December. During cent of GDP in 2014 to 5.2 percent in 2015. plunge in oil prices and reduced public 2015, international reserves fell from Large spending cuts by the central gov- US$14 billion to US$5 billion, while the ernment were more than offset by a 40 investment, which depressed construction manat depreciated by 100 percent percent decline in the Oil Fund’s revenue. activity. Inflation soared as a result of against the US dollar from AZN0.78/ At the end of 2015, Oil Fund assets stood large manat devaluations, raising con- US$ to AZN1.56/US$. at US$33.5 billion, compared with US$37 cerns about new social vulnerabilities. The current account position finished 2015 billion a year earlier. With still-low oil prices in the forecast, with a surplus of 0.8 percent of GDP, com- Over the past decade, Azerbaijan has expe- pared with a surplus of 13.8 percent in rienced significant and steady poverty re- Azerbaijan’s growth and its fiscal and 2014. Despite the large manat deprecia- duction, led by high consumption growth external positions are likely to weaken tion, the trade balance worsened due to among the less well off. Despite slowing further in 2016. Posing significant down- imports for large-scale public investment growth, the official poverty rate fell from 6 side risks are intensifying financial sector in early 2015. Non-oil exports fell by 6.6 percent in 2012 to 5 percent in 2014. Data percent, reflecting Russia’ recession. are not available, but it appears unlikely vulnerabilities, the slow pace of reforms, Banking-sector vulnerability has been that poverty reduction continued into 2015, and an underdeveloped macroeconomic intensifying. Dollarization increased after when sharp rising inflation likely affected policy framework. February’s devaluation and continued households’ income and consumption. FIGURE 1 Azerbaijan / GDP growth decomposition, 2008- FIGURE 2 Azerbaijan / National poverty headcount rate, 2014 (percentage points/percent) 2001-2013 20.0 percent 60 10.0 50 0.0 40 30 -10.0 20 -20.0 10 2008 2009 2010 2011 2012 2013 2014 2015e Net exports Residual items 0 Change in inventories Gross fixed capital formation Final consumption GDP growth Sources: State Statistical Committee. Sources: State Statistical Committee calculations. MPO 42 Apr 16 78  ●   World Bank ECA Economic Update April 2016 Income from labor, self-employment, and The consolidated fiscal deficit is projected fiscal space to provide social protection for pensions—key sources of poverty reduc- to widen significantly to 14 percent of vulnerable households. tion in Azerbaijan—are to a large extent GDP in 2016, driven by higher social rooted in budgetary support, and there- spending (about 4 percent of GDP) and fore are reliant on oil revenues. Construc- tion, which benefits from public invest- larger public investment, including con- struction of the Southern Gas Corridor Risks and challenges ment, has experienced a large contraction, pipeline (4.25 percent of GDP). The bulk with serious implications for employment of public investment will take place out- Azerbaijan’s key challenge remains and income. Agricultural growth of 4.4 side the country, so its impact on the do- reliance on oil in the face of volatile percent helped protect incomes among the mestic economy is likely to be limited. The prices and declining oil output. The 38 percent of the population employed in fiscal deficit is expected to narrow over financial sector wrestles with increased this sector. 2017-18 as oil prices gradually recover and fragility. A very sharp increase in dol- large investment ends. larization and rising NPLs could lead The current account deficit is projected to more bank failures, reduced credit, Outlook to widen to 4.7 percent of GDP in 2016, with the fall in oil exports more than and costly debt servicing that inhibits real sector recovery. Limited exchange offsetting the impact of contracting de- rate flexibility, the lack of effective The economy is projected to contract by mand. As oil prices recover, the current monetary policy framework, and low 1.9 percent in 2016, weakened by low oil account is projected to return to surplus levels of market development inhibit prices, tight monetary conditions, and over 2017-18. the economy’s flexibility to respond to erosion of real income due to inflation. While data limitations do not allow for shocks. Limited reforms in the past With a gradual recovery of oil prices, poverty projections, poverty can be ex- have delayed modernization and growth is likely to pick up in 2017 and pected to rise over 2016-18 in a context of productivity growth in the non - oil reach 1.3 percent in 2018. slow growth, high inflation, and limited tradable sectors. TABLE 2 Azerbaijan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 5.8 2.8 1.1 -1.9 0.7 1.3 Private Consumption 8.1 8.5 6.0 -2.6 2.0 2.4 Government Consumption 9.0 4.0 -4.1 -5.7 1.2 2.1 Gross Fixed Capital Investment 19.4 4.4 -11.5 -17.0 -3.0 0.8 Exports, Goods and Services 1.5 -1.1 -1.0 -2.0 -0.7 -0.7 Imports, Goods and Services 10.0 4.1 -5.0 -10.0 -0.8 0.2 Real GDP growth, at constant factor prices 5.6 2.7 1.1 -1.9 0.7 1.3 Agriculture 4.9 -2.6 6.0 4.2 4.0 4.0 Industry 1.8 -1.7 2.0 -3.0 1.4 1.4 Services 16.9 15.1 -2.0 -1.0 -1.8 0.3 Inflation (Consumer Price Index) 2.5 1.5 7.7 14.0 2.4 2.1 Current Account Balance (% of GDP) 16.5 13.8 0.8 -4.7 3.1 4.7 Financial and Capital Account (% of GDP) -13.9 -10.1 -9.8 -10.1 -15.0 -14.3 Net Foreign Direct Investment (% of GDP) 1.5 3.2 3.4 5.0 4.8 4.8 Fiscal Balance (% of GDP) 1.4 -0.4 -5.2 -14.4 -7.0 -3.2 Debt (% of GDP) 13.6 15.5 16.1 30.2 35.6 54.7 Primary Balance (% of GDP) 1.7 -0.2 -5.0 -14.2 -6.6 -2.5 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 43 Apr 16 Country Pages ●  79 billion at end-2015, covering one month of BELARUS Recent developments imports of goods and services. Economic weakness led to falling reve- nues from corporate income tax, VAT, and In 2015, the Belarusian economy entered a excise taxes. These losses, however, were recession as real GDP contracted 3.9 per- more than offset by foreign trade tax gains Table 1 2015 cent, compared to a modest increase of 1.6 stemming from an agreement with Russia Population, million 9.5 percent in 2014. The external environment whereby Belarus retains export duties on GDP, c urrent US$ billion 53.5 has deteriorated considerably, leading to a oil products, as well as from the reintro- sharp reduction in total exports of goods duction of export duties on potash fertiliz- GDP per c apita, c urrent US$ 5633 a and services by 24.1 percent, while im- er exports. The Government paid back Poverty rate ($5/day 2005 PPP terms) 0.31 ports shrank by 25.4 percent. In particular, US$2 billion of foreign debt in 2015, of Gini Coeffic ient a 28.0 the slowdown in Russia hit Belarusian which two-thirds was refinanced by tak- Sc hool enrollment, primary (% gross) b 99.1 industrial output, which fell by 6.6 percent ing on new loans from the Russian Gov- b 73.2 y/y, while exports of goods to the Russian ernment and commercial banks. The gen- Life Expec tanc y at birth, years market dropped by 26 percent y/y. Given eral government surplus reached 1.5 per- Sources: World Bank, WDI, and M acro Poverty Outlook. faltering exports and sizeable debt repay- cent of GDP. However, if certain quasi- Notes: (a) M ost recent value (2014) ments in foreign currency coming due, fiscal activities were properly accounted (b) Life Expect ancy data show most recent WDI value (2014) macro policies have been tightened to for, the budget balance would have exhib- narrow external and fiscal balances. ited a small deficit. Gross fixed capital investments fell by The labor market is under stress. SOEs did 15.2 percent y/y due to budget cuts in not shed labor, but rather shortened the capital expenditures and containment of working week. Reduction of real wages directed lending. and incomes, by 3.1 and 5.9 percent, re- Recession in Russia and low commodity Although the nominal broad money spectively, led to a contraction in private prices have had a major impact on Bela- growth exceeded the 30 percent target consumption by 3.3 percent y/y. Yet, the rus’s economy, which shrank 3.9 percent announced by the National Bank of Bela- Government has prevented a rise in pov- in 2015, the first recession in two decades. rus, the recession helped to contain infla- erty by spending more on targeted social Economic outlook remains bleak, with real tionary pressures. Annual inflation stood assistance as the number of applicants at 13.5 percent in 2015, well below the increased. Measured at the international GDP projected to decline by 3 percent in 18±2 percent target and also lower than standard of PPP US$ 5/day, poverty in 2016 and by 1 percent in 2017, subject to the 18.1 percent inflation observed in 2014. Belarus remains low at below 1 percent of uncertainty related to oil prices and devel- The exchange rate policy has mainly re- the population. opments in main trading partners. Alt- sponded to deteriorating conditions in Russia, where the Ruble (RUR) has moved hough the poverty impact has remained muted so far, households’ disposable in- in tandem with oil prices. During 2015, the Belarusian Ruble (BYR) depreciated Outlook comes are expected to deteriorate. against the US$ by 36 percent, and vis-à- vis the RUR by 19 percent. Foreign re- This outlook is subject to uncertainty re- serves, excluding gold, stood at US$2.7 lated to oil prices and market volatility in FIGURE 1 Belarus / Contributions to quarterly GDP Growth FIGURE 2 Belarus / Actual and estimated poverty rates and GDP per capita (PPP) Statistical discrepancy Poverty Rate (%) GDP per capita (USD PPP) Net exports 70 18,000 Gross capital formation Total consumption of goods and services 16,000 25 60 GDP growth 14,000 20 50 15 12,000 10 40 10,000 5 30 8,000 0 6,000 20 -5 4,000 -10 10 2,000 -15 0 0 -20 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Q2/12 Q1/15 Q1/10 Q2/10 Q3/10 Q4/10 Q1/11 Q2/11 Q3/11 Q4/11 Q1/12 Q3/12 Q4/12 Q1/13 Q2/13 Q3/13 Q4/13 Q1/14 Q2/14 Q3/14 Q4/14 Q2/15 Q3/15 $2.5/day PPP $5/day PPP GDP per capita PPP Sources: WB Staff calculations based on Belstat data. Source: World Bank (see notes to Table 2). MPO 44 Apr 16 80  ●   World Bank ECA Economic Update April 2016 Russia, the CIS, and Ukraine. Real GDP is compared to 8.7 percent in 2013-2014. Ex- imposed quantitative and employment projected to contract by 3 percent in 2016 ternal financing needs, however, are sub- targets toward productivity and profita- and by 1 percent in 2017. Progress on stantial because of maturing foreign liabil- bility, with their managerial autonomy structural reforms would bolster medium- ities. As the level of international reserves strengthened by appropriate corporate term prospects, but growth is unlikely to is low, the repayments of foreign currency governance arrangements. More room for pick up immediately because of lags in -denominated public debt – estimated to the development of the private sector can diversifying products and markets, partic- be US$3.3 billion in 2016, of which one- help unleash productivity and employ- ularly for SOEs. Risks remain considera- third is due to domestic residents – could ment growth. ble. A steeper slowdown in neighboring only be met by partial refinancing. The The negative impact of large-scale reforms markets would lead to a sharper reces- Government is seeking official financing needs to be mitigated. A reduction in gov- sion, particularly since mineral products assistance from the IMF (up to US$3 bil- ernment directed lending, compounded and fertilizers account for more than a lion) and the Eurasian Fund for Stabiliza- by the growing debt overhang in the real third of total exports. tion and Development of the EurAsEc (up sector, could lead to wage and tax arrears, Further monetary and fiscal tightening to US$2 billion) to support international further spreading the shock among house- would be necessary to adjust to external reserves and debt service obligations. holds and public finances. To address shocks, adding to contractionary pressures. social concerns related to enterprise re- Limited access to external financing and structuring and layoffs, revamping the increasing losses in the SOE sector con- strain the space for countercyclical policies. Risks and challenges current unemployment benefits system would help. Additional social assistance Continued distress in the SOE sector will would be required for households to cope be deleterious to employment creation and Growth can be spurred by appropriately with increases in utility tariffs, but appro- job transition, in a context where existing sequenced reforms, supported by interna- priate modalities of support have yet to be unemployment benefits are extremely low, tional partners and investors. Restructur- designed and implemented. while the Government plans on expanding ing the SOE sector is essential to reduce them are not yet clarified. distortive state interventions and improve The current account deficit is projected to firms’ performance. Companies in the average 3 percent of GDP in 2016-2017 public sector should move away from TABLE 2 Belarus / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 1.1 1.6 -3.9 -3.0 -1.0 0.3 Private Consumption 10.8 4.4 -3.0 -1.5 -0.5 0.2 Government Consumption -2.0 -1.8 -1.8 0.0 0.3 0.1 Gross Fixed Capital Investment 3.8 -8.8 -8.6 -9.2 -2.0 0.8 Change in Inventories, % contrib. 1.9 1.9 0 0 0 0 Exports, Goods and Services -14.6 5.3 -4.2 -1.5 0.5 1.2 Imports, Goods and Services -4.2 2.4 -7.0 -3.0 0.2 1.0 Real GDP growth, at constant factor prices 1.6 2.0 -4.2 -2.5 -0.9 0.4 Agriculture -4.2 3.9 -2.8 -2.0 0.5 1.6 Manufacturing -1.9 0.5 -6.6 -5.5 -2.2 0.3 Services 8.2 3.4 -1.8 -0.4 0.2 0.2 Inflation (Household Consumption Deflator) 17.3 18.0 18.0 17.0 16.0 16.0 Inflation (Consumer Price Index) 18.3 18.1 13.5 14.0 13.0 11.5 Current Account Balance (% of GDP) -10.0 -6.9 -3.8 -2.8 -3.0 -3.3 Fiscal Balance (% of GDP)a 0.2 1.2 1.3 0.2 0.4 0.7 Poverty rate ($5/day PPP terms) b 0.44 0.31 0.36 0.37 0.38 0.37 So urces: Wo rld B ank. No tes: f = fo recast. (a)Fiscal B alance do es no t include extra-budgetary and quasi-fiscal expenditures. (b)Calculatio ns based o n ECA P OV harmo nizatio n, using 201 4-HHS. P ro jectio n using neutral distributio n (201 4) with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . A ctual: 201 3, 2014. P ro jectio ns are fro m 2015 to 2018. MPO 45 Apr 16 Country Pages ●  81 month of y/y declines). Declining consum- BOSNIA AND Recent developments er prices provided some boost to real in- comes given the limited growth in nominal earnings. However, they also increase the HERZEGOVINA Economic growth performed better-than- expected in 2015. Net exports were the real burden of debt, potentially adding to the asset quality concerns faced in the main driver of growth, with consumption banking system (with the non-performing also supportive and investment a drag on to total loan ratio at 13.7 percent). Credit growth. Real GDP expanded by 4.3 percent growth remains weak, giving limited sup- 2015 year-on-year (y/y) in Q2 –the highest rate in port to economic activity. Population, million 3.8 the last five years – and by 3.1 percent in Falling oil prices contributed to declining GDP, current US$ billion 15.5 Q3. On the production side, manufacturing imports and improved external demand GDP per capita, current US$ 4078 and retail trade contributed around half the supported exports. Imports fell by 2.1 Gini Coefficient a 0.33 growth of real value added in the first three percent y/y in 2015 while exports, mainly Life Expectancy at birth, years b 76.1 quarters of 2015. High frequency data sug- to regional neighbors and the EU, in- gest softening GDP dynamics in late 2015, creased by 3.5 percent. The trade deficit Sources: World Bank, WDI, and Macro Poverty Outlook. and we project growth to be 2.8 percent for over the period, valued in euro, fell by 8.7 Notes: 2015 as a whole. percent to €3.5 billion (but remains at just (a) Gini data based on ECATSD (2011) The growth pick-up has not been reflected under 30 percent of GDP). This contribut- (b) Life Expectancy data show most recent WDI value (2013) in labor market performance. Unemploy- ed to a narrowing in the current account ment remains high, at 27.7 percent, with deficit to a projected 6.3 percent of GDP. the number of persons in paid employ- While the fiscal deficit in 2015 is projected ment rising by only 1.9 percent y/y in No- to remain broadly unchanged, at 2 percent vember 2015. Net earnings were stagnant of GDP, there are some positive signs of We project growth in Bosnia and Herze- throughout 2015 across most sectors (up improvements in budgetary processes and only 0.5 percent y/y in nominal terms). In steps towards much-needed improve- govina (BH) in 2015 to reach 2.8 percent. a positive development both Republika ments in the quality and structure of Growth was higher than expected with a Srpska (RS) and the Federation of Bosnia spending. For example, a moratorium on supportive external environment boosting and Herzegovina (FBH) adopted new employment in the public sector was in- net exports and domestic activity re- labor laws to address some long-standing troduced for 2016 and pension reforms are rigidities, aiming to support future job ongoing in FBH. Given previous delays in bounding from the impact of the 2014 creation. However, the FBH constitutional budget adoption, the adoption of all three floods. However, labor market support for court recently ruled that the FBH law 2016 budgets by the end December 2015 poverty reduction was limited, with little needed to return to Parliament due to was also a positive sign, at least relative to improvement in employment and wages violation of procedure. the delays of recent years. largely stagnant. Reforms are being ad- Consumer price deflation persists, driven The potential adoption of a new IMF pro- by lower imported goods prices, including gram, which is under discussion, will pro- vanced in a number of areas, such as labor those linked to international oil prices. The vide an anchor for the medium-term mac- regulations and public finances, with the consumer price index declined by 1.3 per- ro-fiscal framework and, along with sup- potential to improve future job creation. cent y/y in December (the 13th consecutive port from the EC and World Bank, help to FIGURE 1 Bosnia and Herzegovina / Contributions to annual FIGURE 2 Bosnia and Herzegovina / Labor market indica- GDP growth tors, 2015 Percent Percent 6.0 45 40 4.0 35 30 2.0 25 0.0 20 15 -2.0 10 -4.0 5 2010 2011 2012 2013 2014 2015e 2016f 2017f 0 Private consumption Government consumption Activity rate Employment rate Unemployment Unemployment Gross fixed investment Net exports rate rate over 1 year GDP in duration Sources: BHAS, World Bank staff estimate. Sources: LFS 2015 report, World Bank staff calculations. MPO 46 Apr 16 82  ●   World Bank ECA Economic Update April 2016 address underlying fiscal challenges, Adverse shocks to external trade and towards investment and private -sector which are a major focus of the Reform financial conditions, along with limited led growth and away from consumption. Agenda adopted by the authorities in mid progress in implementing the reform Reform of a large, highly decentralized -2015. In another important development, agenda are the main risks to this out- and fragmented public sector is a funda- BH formally submitted its application for look, impacting in particular net exports mental component of this rebalancing. EU membership in mid-February 2016. and investment. The fiscal deficit is pro- Although fiscal deficits remain relatively jected to remain around 2 percent of moderate, the fiscal sector remains char- GDP through 2018 with gradual imple- acterized by a high tax burden and ineffi- Outlook mentation of reforms to reduce current spending, for example, on wages, and to cient patterns of spending. Fiscal consoli- dation efforts will not be effective if improve revenue performance, for ex- structural rigidities on the expenditure Supported primarily by domestic demand ample, by addressing VAT fraud and side remain unaddressed, e.g. a large growth, we project economic growth to tax arrears. public wage bill and sizeable and poorly strengthen to above 3 percent in the medi- Unemployment, particularly among targeted social assistance. The adoption um term. Investment is projected to pick- youth, is expected to remain high but to of a proposed IMF program, and support up as a result of improvements in the busi- move onto a declining path. However, from other partners including the World ness environment from implementation of given the substantial remaining slack in Bank, can help the authorities to deliver the Reform Agenda, as well as from a the labor market, real wages are expected on this challenging agenda . number of specific investments in the ener- to remain largely flat. As a result, the pov- Sustained reform progress across the gy and tourism sectors. External condi- erty headcount is forecast to improve only broader areas of focus of the Reform tions will support a stable inflow of re- marginally. While ongoing reforms may Agenda is also a challenge, given the mittances which, combined with sustained support future labor market performance sensitive nature of reforms of labor lower oil prices, will underpin a gradual a high tax wedge, especially among low- markets and social policy, as well as the pick up in consumption, which will re- wage workers, makes job creation particu- local elections later in 2016. Reforms main a key driver of growth. The recovery larly problematic for low-skilled workers may also have near -term distributional in EU import demand will also lead to a among the poor and the B40. implications which may require miti- moderate rise in exports. However, net gating measures. However, despite external demand will continue to be a drag these challenges, sustained implemen- on growth, given the relative strength of domestic demand for imports. As a result Risks and challenges tation of the reform agenda is a pre - requisite for improved shared prosperi- of these dynamics, we project real GDP ty and poverty reduction over the medi- growth to strengthen gradually from 2.8 The key economic challenge faced by the um term, and for progress towards EU percent in 2015 to 3.5 percent in 2018. country is rebalancing the economy membership. TABLE 2 Bosnia and Herzegovina / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 2.4 1.1 2.8 2.6 3.1 3.5 Private Consumption 0.0 2.2 1.2 1.8 2.5 2.5 Government Consumption -0.6 0.9 -1.3 2.6 2.8 3.0 Gross Fixed Capital Investment -0.9 10.1 -11.0 5.8 7.4 9.6 Exports, Goods and Services 7.9 4.2 3.0 2.0 2.5 3.0 Imports, Goods and Services -0.1 8.1 -1.7 2.0 3.0 3.5 Real GDP growth, at constant factor prices 2.5 1.2 2.8 2.6 3.1 3.5 Agriculture 16.1 -9.4 0.5 1.0 2.0 2.0 Industry 3.7 0.0 2.0 2.5 3.0 3.0 Services 0.4 3.2 3.5 2.8 3.3 3.9 Prices: Inflation 0.8 -0.5 -0.7 -0.6 0.9 0.9 Current Account Balance (% of GDP) -5.7 -7.8 -6.3 -6.4 -7.1 -8.0 Financial and Capital Account (% of GDP) 4.8 6.7 6.3 6.4 7.1 8.0 Net Foreign Direct Investment (% of GDP) 1.6 2.6 1.4 1.7 1.9 2.3 Fiscal Balance (% of GDP) -1.9 -2.0 -1.7 -2.1 -2.1 -1.9 Debt (% of GDP) 40.8 43.0 43.8 45.2 45.6 48.4 Primary Balance (% of GDP) -1.2 -1.3 -0.7 -1.1 -1.2 -0.8 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 47 Apr 16 Country Pages ●  83 and with high regional variation. Inac- BULGARIA Recent developments tivity among certain groups of popula- tion is also high as a result of education system with deteriorating quality and Economic recovery strengthened in 2015 rising inequality, and a large number of following five years of slow economic people excluded from economic oppor- Table 1 2015 growth. GDP grew by 3 percent in 2015, tunities, such as elderly, people living in Population, million 7.2 a significant improvement compared to rural areas, and the Roma. Excluding a GDP, c urrent US$ billion 49.1 2009-14. Exports expanded at robust rate large number of people is damaging for GDP per c apita, c urrent US$ 6838 and were the key driver of growth de- growth in the case of Bulgaria which is a spite the crisis in neighboring Greece and undergoing the steepest decline in popu- Poverty rate ($2.5/day 2005PPP terms) 5.6 a heightened geopolitical tensions. Domes- lation in the world. Poverty rate ($5/day 2005PPP terms) 16.4 tic demand benefited from a spur in in- Accelerated economic activity and im- a Gini Coeffic ient 36.0 vestment from intensified implementa- proved tax compliance strengthened Sc hool enrollment, primary (% gross) b 99.5 tion of EU-funded projects, continuing Bulgaria’s fiscal position. The fiscal defi- Life Expec tanc y at birth, years b 74.3 labor market improvements, and low cit, estimated at 2.5 percent of GDP in inflation. Consumption recovered in the 2015, was better than expected. Buoyant Sources: World Bank WDI and M acro Poverty Outlook. Notes: second half of the year as declining un- tax revenues and accelerated absorption (a) M ost recent value (2012) employment, rising wages and a low of EU funds supported the achievement (b) M ost recent WDI value (2013) inflation boosted real household in- of the fiscal outcome despite difficulties comes. Unemployment declined to a six - in implementing the planned cuts in the year low (7.9 percent of the labor force in wage bill in some sectors. Government Q4-2015) while new jobs were created in debt is projected to have increased to sectors -- such as construction and indus- 28.1 percent of GDP in 2015. Debt re- Bulgaria’s economic recovery strength- try -- that were the hardest hit during the mains the third lowest in the EU. ened in 2015 and supported improved 2009 crisis and that employ a relatively The external current account was again fiscal performance but the medium-term large share of low-skilled labor, boding in surplus supported by further narrow- outlook remains challenging. Stronger well for poverty reduction. ing of the trade balance. Bulgaria export- growth and improvements in labor mar- Estimated poverty declined modestly ed more investment goods and raw ma- from 15.3 percent in 2014 to 14.5 percent terials, especially to the EU, while import kets have contributed to poverty reduc- in 2015 (5.5 percent to 5.0 percent, re- growth was modest in line with low oil tion. Further gains in growth, poverty spectively, at the $2.50 poverty line). prices and was concentrated in invest- reduction and shared prosperity would This reflects a mix of employment and ment and consumer goods. On the basis hinge on strengthening institutions, wage gains among low -skilled workers, of the improved external position, re- especially in the construction sector, and duced exposures of Greek -owned banks boosting the skills and employability of relatively static pensions and social ben- in Bulgaria, and one -off factors affecting the labor force, and improving the effec- efits for the large share of poorer house- intercompany lending, external private tiveness and efficiency of public spending. holds that are out of the labor market. debt shrank by almost 14 percentage Nevertheless, unemployment is still points of GDP in a year, to 63.1 percent high, especially long -term and youth, of GDP in 2015. FIGURE 1 Bulgaria / Contributions to annual growth, per- FIGURE 2 Bulgaria / Poverty Rates centage points 15 20 10 15 5 10 0 -5 5 -10 0 2009 2011 2013 2015 2017 -15 Moderate poverty ($5/day) 2007 2008 2009 2010 2011 2012 2013 2014 2015 Extreme poverty ($2.5/day) Consumption Gross capital formation Moderate poverty projection Net Exports GDP Extreme poverty projection Sources: NSI and World Bank staff estimates. Sources: World Bank. MPO 48 Apr 16 84  ●   World Bank ECA Economic Update April 2016 activating young people not in education, in productivity and in labor force partici- Outlook employment or training are expected to help reduce poverty as well. pation. According to a recent World Bank report, Bulgaria will need to raise its The external current account is expected productivity growth to at least 4 percent GDP growth is projected to slow to 2.2 to continue to be in surplus as economic per year to reach the average EU income percent in 2016 as the impact of higher activity firms before shifting to a small levels within a generation. Yet, recent absorption of EU funds on public invest- deficit in 2018. Export growth is likely to productivity growth has been disappoint- ment and consumption diminishes sharp- slow in response to a weakening outlook ing while improvements in labor force ly with the start of the new financing pe- in emerging markets. Import growth is participation have been constrained by riod. Private investment is likely to con- likely to be affected by weakening do- weak demand and skill shortages while a tinue to be weak in line with still con- mestic demand for investment goods. large portion of the population is at risk of strained lending. Going forward, the eco- Fiscal consolidation is likely to continue poverty or social inclusion. nomic recovery is projected to be modest, in 2016 and beyond. The fiscal deficit is Addressing the challenge of convergence with growth picking up to 2.7 percent in expected to be reduced to 2.2 percent of would require stepping up reforms to 2017 and 3 percent in 2018. Recovery of GDP in 2016 and to 1.3 percent by 2018. strengthen the legal and institutional external demand is likely to be slow as a Limited improvements in spending effi- framework, boosting the skills of the labor result of weakening of growth in emerg- ciency of select sectors could undermine force, and increasing effectiveness of pub- ing markets and lingering geopolitical fiscal consolidation plans going forward lic spending. tensions in the region. and limit the potential of public spending Reforms to strengthen the effectiveness of Poverty at the $5 poverty line is expected to enhance growth. High contingent lia- the judiciary, reduce the potential for cor- to continue declining slowly to 13.9 per- bilities in the energy and banking sector ruption, and improve the regulation of cent in 2016, 13.2 percent in 2017 and 12.5 present risk to fiscal accounts. energy and financial sector could percent in 2018 (4.8, 4.5 and 4.2 percent, strengthen confidence and reduce fiscal respectively, at the $2.50 poverty line). pressures. Improving the education out- Increased child benefits (for a second child or twin) and children with perma- Risks and challenges comes can have a significant impact on poverty reduction and shared prosperity. nent disabilities are expected to contrib- Enhancing the effectiveness of public ute to poverty reduction, as is financial The key challenge for Bulgaria is to accel- spending on pensions, health and long- support to cover heating costs for chil- erate convergence with the rest of the EU term care will be important for boosting dren and the elderly. Labor market devel- and deal with the negative consequences Bulgaria’s growth and ensure more inclu- opments such as minimum wage increas- of its demographic change. Accelerating sive and sustainable growth. es and the Youth Guarantee program for convergence would require improvements TABLE 2 Bulgaria / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 1.3 1.6 3.0 2.2 2.7 3.0 Private Consumption -1.4 2.7 0.8 2.1 2.6 3.3 Government Consumption 2.2 0.1 0.3 1.2 1.4 1.7 Gross Fixed Capital Investment 0.3 3.4 2.5 1.4 2.3 2.6 Exports, Goods and Services 9.2 -0.1 7.6 4.2 4.4 4.8 Imports, Goods and Services 4.9 1.5 4.4 3.7 4.0 4.9 Real GDP growth, at constant factor prices 1.1 1.8 1.5 2.2 2.7 3.0 Agriculture 3.2 5.2 -1.4 1.0 1.2 1.5 Industry 0.2 0.9 2.8 2.2 3.0 3.3 Services 1.3 1.9 1.2 2.4 2.7 3.0 Inflation (Consumer Price Index) 0.9 -1.4 -1.1 -0.2 1.1 1.4 Current Account Balance (% of GDP) 1.3 0.9 1.4 1.1 1.0 -0.1 Financial and Capital Account (% of GDP) -1.0 2.8 -3.1 -0.1 -0.4 -0.1 Foreign Direct Investment in Bulgaria (% of GDP) 3.3 3.1 3.6 3.5 3.7 3.8 Fiscal Balance (% of GDP) -0.8 -5.8 -2.5 -2.2 -1.9 -1.3 Debt (% of GDP) 18.0 27.0 28.1 29.5 30.2 30.5 Primary Balance (% of GDP) -0.1 -4.9 -1.5 -1.2 -1.0 -0.4 Poverty rate ($2.5/day 2005 PPP terms) a,b,c 5.5 5.5 5.0 4.8 4.5 4.2 Poverty rate ($5/day 2005 PPP terms) a,b,c 15.8 15.3 14.5 13.9 13.2 12.5 So urces: NSI; B NB ; Euro stat; Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 2-EU-SILC. (b) P ro jectio n using neutral distributio n (201 2) with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 2. P ro jectio ns are fro m 2013 to 2018. MPO 49 Apr 16 Country Pages ●  85 to have decreased from 9.8 percent in CROATIA Recent developments 2014 to 9.0 percent in 2015. The decline is likely to have happened despite a de- crease in real pensions by 0.5 percent in After a prolonged recession, Croatia 2015 as the number of new early retirees started a gradual recovery in 2015 reach- increased. Compared to the pre -crisis Table 1 2015 ing an annual growth of 1.6 percent. level, real per capita income in 2015 was Population, million 4.2 Growth was led by exports of goods and about 8 percent lower. GDP, c urrent US$ billion 49.0 services, underpinned by EU recovery, as Fiscal vulnerabilities declined in 2015, led GDP per c apita, c urrent US$ 11580 well as higher private consumption, by improved tax collection and a lower Poverty rate ($2.5/day 2005PPP terms) a 2.1 boosted by oil and food price declines, wage bill. The general government deficit a income tax changes and labor market declined to a still high 4.7 percent of GDP Poverty rate ($5/day 2005PPP terms) 9.4 a recovery. on an accrual basis from 5.6 percent in Gini Coeffic ient 32.5 Administrative unemployment data con- 2014, and public debt rose further to al- b Sc hool enrollment, primary (% gross) 96.8 tinued its downward trend, reflecting most 88 percent of GDP. During 2015, Life Expec tanc y at birth, years b 76.9 growth both in public and private service limited progress was registered in the Sources: World Bank WDI and M acro Poverty Outlook. employment. In 2015, Croatia doubled area of fiscal governance, including the Notes: the amount of employment subsidies reform of the public administration and (a) M ost recent value (2012) (b) M ost recent WDI value (2013) supported by the EU Youth Guarantee the adoption of a public debt manage- Scheme and strengthened other active ment strategy. Some of the saving labor market programs for vulnerable measures identified in the spending re- groups, which led to employment view are being implemented, but at a growth. Still, the unemployment rate at slow pace. The reform of wage -setting in After six years of recession, Croatia start- 17 percent remained high compared to the public sector and state -owned enter- EU peers. The increase in real net wages prises and the reform of the social protec- ed a gradual recovery in 2015 led by exter- (4.1 percent) due to legislative changes in tion system were put on hold in the run - nal demand and private consumption. the income tax and deflationary pres- up to the elections. Given the labor market recovery, as well as sures, increased disposable household While deposits increased, deleveraging the reduced income taxation and the ex- incomes in 2015. In addition, the govern- continued in 2015 as companies turned to ment adopted a debt relief scheme, a re- direct foreign borrowing. Households pansion of employment subsidies in 2015, duction of the penalty interest rate, a reduced their liabilities to the banking the poverty rate has likely continued measure financing the cost of electricity sector by 1.5 percent in December 2015 trending downwards. The fiscal deficit is for socially-vulnerable households that when the conversion and partial write -off set to continue declining towards 3 per- are already receiving minimal social as- of CHF loans started. So far, households cent of GDP, with the public debt stabiliz- sistance or disability benefits, and con- converted the equivalent of 0.6 percent of version of all CHF-loans to EUR-loans, all GDP in EUR-denominated loans, while ing. Economic growth of 1.9 percent in aimed at easing households’ debt burden 0.3 percent of GDP was written off. Non - 2016, will come from tourism and invest- and helping improve their living stand- performing loans, after their peak in June ments driven by EU funds absorption. ards. As a result, the absolute poverty 2015, slightly declined to 16.6 percent in rate measured at $5/day PPP is expected December 2015. FIGURE 1 Croatia / Contributions to annual GDP growth FIGURE 2 Croatia / Actual and estimated poverty rates and GDP per capita (PPP) Percent Poverty Rate (%) GDP per 10 capita PPP 12 21,000 5 10 20,500 0 8 20,000 -5 6 19,500 4 19,000 -10 2 18,500 -15 0 18,000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016f 2009 2011 2013 2015 2017 Final consumption Gross fixed capital formation Change in inventories Net exports $2.5/day PPP $5/day PPP Residual item GDP growth GDP per capita PPP Sources: World Bank. Sources: World Bank (see notes to table 2). MPO 50 Apr 16 86  ●   World Bank ECA Economic Update April 2016 Addressing structural issues to boost Outlook growth and job creation is expected to be a priority of the new government formed Risks and challenges after the parliamentary elections of early Economic activity is expected to continue November. The 2016 budget aiming to Risks are still skewed to the downside. Ex- recovering in 2016-18 with growth aver- reduce deficit to close to 3 percent of GDP ternal factors, such as a slowdown in Croa- aging 2.1 percent a year, led by strength- and stabilize public debt does not plan to tia’s main trading partners, the Fed’s tight- ened private consumption, exports and reduce pension and wages, but reductions ening monetary policy and increased investment, benefitting from the im- in subsidies and operational costs are emerging market risk premium, could un- proved absorption of EU funds. Private likely to occur. The fiscal consolidation dermine Croatia’s fragile recovery, affecting consumption is expected to grow reflect- path the new government will pursue is exports and raising financing costs. On the ing labor market recovery, increased con- likely to affect investors’ and credit domestic side, high government and private sumer confidence and slowdown in agencies’ decisions. In January 2016, fol- debt, jointly representing more than 200 deleveraging. Stronger utilization of EU lowing Fitch, the S&P affirmed BB/'B percent of GDP in 2014, will continue to funds will boost investment, while gov- credit rating on Croatia with the outlook constrain public and private investment and ernment consumption is projected to re- remaining negative, while in March, household consumption. Debt sustainability main subdued due to the need for fiscal Moody’s downgraded Croatia's rating to analysis indicates high risks in the medium consolidation under the Excessive Deficit Ba2 from Ba1 and maintained the nega- term, while the scope of fiscal consolidation Procedure (EDP) with the EU. The speed tive outlook due to the government's measures for 2016 and 2017 is still uncertain. of adjustment is likely to be slower than large and increasing debt burden and A wage increase of 6 percent planned for prescribed by the EDP, however. continuing weak medium-term economic 2016 as per the 2009 wage agreement and As the growth gradually accelerates, the growth prospects. the delayed cancelation of the loyalty bo- absolute poverty rate measured at US$5/ On the monetary policy side, the current nuses would add additional 0.65 percent of day at PPP is projected to decline to 8.4 account surplus, coupled with the GDP to spending in 2016 that could hamper percent in 2017 and further to 7.7 percent strengthening of banks’ external positions the fiscal consolidation plans. The contin- in 2018, led by labor market improve- and announced fiscal consolidation ued arrears creation in the health sector will ment, in particular in the service sector opened the room for central bank to intro- also require additional savings measures. (tourism, construction and professional duce structural repo operations aimed at Lifting potential growth from the current 1 services). Labor force participation at ensuring long-term liquidity, decreasing percent requires sustained investment and 52.7 percent in 2015 is among the lowest the financing costs for domestic sectors deep structural reforms in labor and espe- in EU and presents a strong determinant and with strengthened domestic demand, cially product markets to support full utili- of low household income and of vulnera- boosting lending in local currency to cor- zation of the labor force, while ensuring bility to poverty. porates and households. robust productivity growth. TABLE 2 Croatia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices -1.1 -0.4 1.6 1.9 2.0 2.4 Private Consumption -1.8 -0.7 1.2 1.2 1.3 1.6 Government Consumption 0.3 -1.9 0.6 0.0 0.5 0.8 Gross Fixed Capital Investment 1.4 -3.6 1.6 3.1 3.7 3.9 Exports, Goods and Services 3.1 7.3 9.2 3.6 3.0 2.9 Imports, Goods and Services 3.1 4.3 8.6 2.6 2.5 2.2 Real GDP growth, at constant factor prices -1.1 -0.1 1.4 1.9 2.0 2.4 Agriculture -0.6 0.0 -0.4 1.5 2.0 2.2 Industry -2.8 0.5 1.9 2.6 2.8 2.8 Services -0.6 -0.3 1.3 1.7 1.7 2.3 Inflation (Consumer Price Index) 2.2 -0.2 -0.5 0.9 1.5 1.9 Current Account Balance (% of GDP) 1.0 0.8 4.5 2.0 1.9 1.7 Financial and Capital Account (% of GDP) 1.0 0.6 -3.6 -0.7 -0.6 -0.5 Net Foreign Direct Investment (% of GDP) 1.9 3.0 1.6 2.7 3.1 3.5 Fiscal Balance (% of GDP) -5.4 -5.6 -4.7 -3.3 -2.8 -2.4 Debt (% of GDP) 80.8 85.1 87.8 88.8 89.0 88.3 Primary Balance (% of GDP) -1.9 -2.1 -1.1 0.2 0.7 1.1 Poverty rate ($2.5/day PPP terms) a,b,c 2.1 2.1 1.7 1.6 1.5 1.4 Poverty rate ($5/day PPP terms) a,b,c 9.8 9.8 9.0 8.7 8.4 7.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 2-EU-SILC. (b) P ro jectio n using neutral distributio n (2012) with pass-thro ugh = 1 based o n GDP per capita co nstant P P P . (c) P ro jectio ns are fro m 2013 to 201 8. MPO 51 Apr 16 Country Pages ●  87 In an environment of weak external de- GEORGIA Recent developments mand and high policy rates the govern- ment supported growth through a 17 per- cent increase in capital expenditures. This The recession in Russia and slower was coupled with a 9 percent increase in growth among other trading partners im- current spending, raising the fiscal deficit Table 1 2015 pacted Georgia through lower exports and to 3.7 percent of GDP in 2015 compared Population, million 3.7 reduced remittances, particularly from with a budgeted deficit of 3 percent. The GDP, c urrent US$ billion 14.0 Russia and Greece. deviation was mainly driven by an over- GDP per c apita, c urrent US$ 3754 The tradable sector suffered the most, with run in current spending and on-lending to Poverty rate ($2.5/day 2005PPP terms) a 32.3 industrial production contracting by one municipalities. a percent in 2015. As a result, growth mod- The poverty rate fell during 2010-14 and is Poverty rate ($5/day 2005PPP terms) 69.4 a erated from 4.6 percent in 2014 to 2.8 per- estimated to have declined further in 2015, Gini Coeffic ient 40.1 cent in 2015. The slower growth was sup- although at a slower pace. The extreme b Sc hool enrollment, primary (% gross) 106.1 ported by non-tradables like construction poverty rate (US$2.5/day) was estimated Life Expec tanc y at birth, years b 73.9 (+15.2 percent) and services (+3 percent) at 32.3 percent in 2014. Increases in sala- Sources: World Bank WDI and M acro Poverty Outlook. and foreign direct investment (FDI). These ries and social transfers drove poverty Notes: sectors helped increase employment by 10 reduction during 2010-14, with the former (a) M ost recent value (2014) (b) M ost recent WDI value (2013) percent in 2015, raising real wages by 3.7 playing a greater role in urban areas. Since percent. The construction, real estate and 2013, agricultural income and employ- health sectors experienced the largest ment opportunities in construction and wage increases. However, unemployment tourism have also contributed to the de- GDP growth slowed to 2.8 percent in remains high, particularly in urban areas cline in poverty levels. However, the rural and among younger workers. poverty rate remains roughly twice the 2015 largely because of a weaker external Driven by a decline in exports and remit- urban rate. environment. With pre-election uncer- tances, the current -account deficit wid- tainty and continued weakness in the ened to 11 percent of GDP, and the lari external markets, growth in 2016 is pro- has lost 30 percent of its value against the US dollar since December 2014. The de- Outlook jected at 3 percent. Public capital spend- preciation raised inflationary expecta- ing supported growth in 2015 but over- tions, leading the National Bank of Geor- With Parliamentary elections scheduled runs in other expenditures raised the fis- gia (NBG) to increase the policy rate from for October 2016 and the weakness in ex- cal deficit to 3.7 percent of GDP. Lower 4 percent in February 2015 to 8 percent in ternal markets likely to persist, growth is corporate income taxes are likely to raise December. The tightening of monetary projected at 3 percent in 2016. The spill- policy together with lower oil prices over effects from the Russia-Ukraine crisis the fiscal deficit over the medium-term. helped contain inflation during 2015 to and the slowdown among Georgia’s main Modest growth and rising inflation are 4.9 percent. Prudent financial sector su- trading partners are likely to push the expected to slow the pace of poverty re- pervision ensured stability of the banking current-account deficit to 10 percent of duction in 2016. sector and low level of NPLs at 2.3 per- GDP in 2016. Greater policy certainty fol- cent in 2015. lowing the election, a modest recovery in FIGURE 1 Georgia / GDP growth decomposition (% contri- FIGURE 2 Georgia / Poverty rates, 2010-2018 (2005 US$ bution) PPP) Contribution to growth, % poverty, % thousand $ 15 90 9.00 10 80 8.50 70 8.00 5 60 7.50 0 50 7.00 -5 40 6.50 -10 30 6.00 20 5.50 -15 2008 2009 2010 2011 2012 2013 2014 2015e 10 5.00 Net export GNFS change in inventories 2010 2011 2012 2013 2014 2015p 2016p 2017p 2018p Gross fixed capital formation Final consumption $2.5/day PPP (left) $5/day PPP (left) GDP GDP per capita (right) Source: Geostat. Source: World Bank Poverty Global Practice. MPO 52 Apr 16 88  ●   World Bank ECA Economic Update April 2016 external markets and strong FDI inflows— growth will slow the pace of poverty re- to Georgia’s European integration aspira- particularly related to the BP-pipeline duction in 2016. Increased construction tions and business friendly policies. expansion, the upcoming Anaklia deep- activity supported by large anticipated Slow growth, a large current-account defi- sea port, and hydro power projects (HPPs) investments and the growth of tourism- cit, high levels of external debt, a widening —are projected to boost growth to 4.5 per- related services are expected to drive job fiscal deficit, elevated rural poverty and cent in 2017 and 5 percent in 2018. The creation and poverty reduction. The rise high rates of unemployment are among the current account deficit is also expected to in real salaries observed since 2010 is also main challenges to economic growth and go down gradually in the outer years. likely to continue, which should further poverty reduction in Georgia. Given its Georgia’s anticipated adoption of the Es- reduce poverty rates, while the expected limited domestic savings, Georgia relies on tonian tax model, which would replace increase in pensions will have a positive foreign savings to finance the bulk of its the corporate profit tax with dividend tax, distributional impact. However, fiscal investments. This has led to persistently is expected to increase the fiscal deficit in constraints are expected to limit the role of high current-account deficits, with external the short-to-medium term. While this social assistance in the future. Moreover, debt exceeding 100 percent of GDP. Falling measure could boost medium-term higher food prices in 2016 will dispropor- exports and remittance inflows, a high growth, tax revenues will decline immedi- tionately affect the purchasing power of level of dollarization at 65 percent and low ately. Besides, pensions will rise by 12.5 households at the bottom of the income reserves (3 months of imports) have percent in July 2016 and teachers’ salaries distribution, as food represents a larger heightened foreign-exchange risks. Miti- will increase further in April. Thus total share of their consumption basket gating factors include the floating ex- expenditures are expected to exceed 30 change rate, market access and the support percent of GDP in 2016 and the fiscal defi- of international financial institutions. Fall- cit is projected to increase to 4-5 percent of GDP, assuming that the Estonian tax mod- Risks and challenges ing corporate tax revenues, increases in recurrent spending and contingent liabili- el is adopted in 2016. The decline in tax ties arising from power-purchase agree- revenues is likely to persist over the medi- Political and policy uncertainty stemming ments are all sources of fiscal risk. The gov- um-term which will keep the deficit level from the October parliamentary elections ernment will need to better manage aggre- elevated compared with the past. The along with the existing geopolitical risks gate demand through lower deficits and stock of public debt is also likely to in- could weaken consumer and business establish an adequate mechanism to moni- crease with increased deficit levels. confidence and slow the pace of reforms. tor and reduce contingent liabilities. The Poverty levels are anticipated to decrease However, overall policy continuity is like- contribution of social benefits to poverty further during 2016-18, although food- ly to be maintained, as both the ruling and reduction will also need to be balanced price inflation and modest economic opposition parties are equally committed against labor force participation objectives. TABLE 2 Georgia / Key Economic Indicators (% change unless otherwise indicated) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 3.4 4.6 2.8 3.0 4.5 5.0 Private Consumption -0.1 3.2 5.4 -2.6 2.6 5.5 Government Consumption 4.3 11.2 3.5 5.5 5.7 3.8 Gross Fixed Capital Investment -10.1 24.4 4.2 -3.9 3.9 7.0 Exports, Goods and Services 20.3 0.4 -10.9 3.8 4.0 6.9 Imports, Goods and Services 2.9 11.1 -6.6 -5.2 2.0 7.3 Real GDP growth, at constant factor prices 3.8 4.4 3.0 2.4 4.4 4.8 Agriculture 11.3 1.6 2.9 3.0 4.0 2.0 Industry 3.6 4.5 3.4 6.0 6.0 5.0 Services 3.1 4.7 3.0 1.2 3.9 5.1 Inflation (Private Consumption Deflator) 0.6 4.5 7.7 3.9 3.7 4.7 Current Account Balance (% of GDP) -5.8 -10.6 -11.0 -10.0 -8.8 -8.3 Financial and Capital Account (% of GDP) 5.8 10.6 11.0 10.0 8.8 8.3 Net Foreign Direct Investment (% of GDP) 5.1 8.1 9.1 9.8 9.5 8.9 Poverty rate ($2.5/day PPP terms) a,b,c 36.0 32.3 31.0 29.4 27.5 25.5 Poverty rate ($5/day PPP terms) a,b,c 73.3 69.4 68.2 66.8 64.4 62.0 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice.Due to pending tax refo rms and expenditure adjustments, fiscal indicato rs are no t repo rted in No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 4-HIS. (b) P ro jectio n using neutral distributio n (201 4) with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 3, 2014. P ro jectio ns are fro m 2015 to 2018. MPO 53 Apr 16 Country Pages ●  89 and tightening tenge liquidity. In Au- KAZAKHSTAN Recent developments gust, however, the central bank an- nounced the shift to a floating exchange - rate regime and inflation targeting. The Falling oil prices and weakened domestic tenge lost almost half its value against and export demand in China and Russia the US dollar between mid -August (KZT Table 1 2015 caused Kazakhstan’s GDP growth rate to 188/US$) and end-December 2015 (KZT Population, million 17.5 slow from 4.1 percent in 2014 to 1.2 per- 340/US$). The depreciation helped re- GDP, c urrent US$ billion 189.6 cent in 2015. The move to a floating ex- duce imports in Q4 2015, but the steep GDP per c apita, c urrent US$ 10840 change-rate regime in August 2015 led to drop in export revenue turned the cur- Poverty rate ($2.5/day 2005PPP terms) a 0.4 a sharp depreciation of the tenge (KZT), rent-account balance from a surplus of a which negatively affected private domes- 2.6 percent of GDP in 2014 to a deficit of Poverty rate ($5/day 2005PPP terms) 15.2 tic demand and intensified inflationary 2.9 percent in 2015. While foreign - Gini Coeffic ient a 26.3 pressures. Industrial output contracted by exchange-denominated loans represented b Sc hool enrollment, primary (% gross) 104.9 1.6 percent in 2015, while the service- just 23.2 percent of total loans in August Life Expec tanc y at birth, years b 69.6 sector growth rate fell from 5.7 percent in 2015, the banking sector will be subject Sources: World Bank WDI and M acro Poverty Outlook. 2014 to an estimated 2.3 percent in 2015. to increasing pressure, as the share of Notes: Agricultural production grew by an esti- nonperforming loans is expected to rise. (a) M ost recent value (2013) (b) M ost recent WDI value (2013) mated 4.4 percent, but the sector’s contri- Weak domestic demand put downward bution to GDP growth is relatively minor. pressure on the inflation rate, which fell to Some labor market indicators are begin- a historic low of 3.8 percent, year-on-year ning to weaken. Real wages declined by (y/y), in August 2015 before the pass- 2.4 percent between 2014 and 2015, and through effect of the depreciation caused the official unemployment rate remained it to spike, reaching to 13.6 percent, y/y, in at 5 percent in 2015 before rising to 5.1 December 2015. Worsening terms of trade, Kazakhstan’s growth is slowing from 1.2 percent in January 2016. coupled with wealth and price effects re- percent of GDP in 2015 to an estimated The government continued to implement lated to the depreciation, are expected to 0.1 percent in 2016 due to low global oil the anti-crisis program launched in late erode household purchasing power. prices and weakened domestic and exter- 2014. Falling oil prices and a large-scale Progress on poverty reduction largely off-budget investment initiative led to a stalled in 2014 and 2015 due to slow nal demand. Growth is expected to pick deterioration of the consolidated fiscal growth and a weak labor market. The up over 2017-18 as oil prices recover and stance from a balanced position in 2014 to government is attempting to soften the oil production increases, but will remain a deficit of 7.8 percent of GDP in 2015, impact of the slowing economy by pro- below its long-run potential. Weak job despite cuts in budgetary outlays. tecting social spending and increasing creation will limit progress on poverty The continued decline of oil prices in 2015 pensions. However, pro -poor transfer increased external imbalances and fueled programs are still relatively undevel- reduction in the near term, but a decline speculative pressure on the tenge. The oped, leaving low-income households in the poverty rate is anticipated in 2017- central bank intervened aggressively to vulnerable to rising food prices, falling 18 as growth accelerates. defend the exchange rate until mid-2015, real wages and diminished employment providing injections of foreign exchange opportunities. FIGURE 1 Kazakhstan / Contribution to GDP growth FIGURE 2 Kazakhstan / Actual and estimated poverty rates and GDP per capita (PPP) Percent/percentage points Poverty Rate (%) GDP per capita (USD PPP) 10 90 25,000 8 80 6 70 20,000 4 60 15,000 2 50 40 0 10,000 30 -2 20 5,000 -4 10 -6 2011 2012 2013 2014 2015e 0 0 Consumption Investment 2001 2003 2005 2007 2009 2011 2013 2015 2017 Net exports Statistical discrepancy $2.5/day PPP $5/day PPP GDP growth GDP per capita PPP Source: World Bank estimates based on data from Statistical Office of Kazakhstan. Sources: World Bank (see notes to table 2). MPO 54 Apr 16 90  ●   World Bank ECA Economic Update April 2016 implementation of structural reforms risk. First, oil prices may fall below the Outlook designed to support private-sector devel- opment and economic diversification. baseline projection of US$37 per barrel. Second, progress on the structural re- The poverty rate is projected to show a form agenda to support diversification The GDP growth rate is projected to fall small uptick in 2016 before declining at may stall, , especially the privatization of to just 0.1 percent in 2016, while inflation a moderate pace over 2017 -2018 as the state-owned enterprises and key revi- is expected to remain elevated. These economy recovers. However, since the sions to the regulatory framework. And projections are based on the current 2016 initial rebound in growth will result third, insufficient coordination between oil price forecast of US$37 per barrel, and primarily from the oil sector, rather macroeconomic policies and structural no major improvement in external condi- than being broad based, wages will re- reforms may adversely affect the quality tions is anticipated over the near term. main subject to downward pressure in of growth and its contribution to job The current-account deficit is expected to 2017 and employment growth will im- creation, which could have negative wel- worsen as the economy continues to ad- prove only marginally. As inflation con- fare implications, particularly for poor just to low oil prices. Consumer price tinues to affect consumer purchasing households. Moreover, the quality of the inflation is projected to peak in 2016 be- power, and demand declines as real fiscal adjustment will hinge on improve- fore falling back to single digits by the wages fall, strengthening targeted so- ments in the quality and efficiency of end of the year as the effect of the tenge’s cial assistance programs may temporar- expenditures, while the implementation depreciation on domestic prices fades. ily help protect the poor. of inflation targeting and the floating Nevertheless, consumer prices are ex- Going forward, the government plans to exchange-rate regime will depend on the pected to rise by an average of about 13.7 consolidate its fiscal stance and reduce the monetary authorities ensuring adequate percent over the year. GDP growth is nonoil deficit to a more sustainable level capacity building for and systematic projected to pick up to about 1.9 percent over the medium term. The government communication about the reform agen- in 2017 and 3.7 percent in 2018, assuming recently announced an ambitious reform da. If a broad-based recovery fails to that average oil prices will recover to agenda, supported by ongoing efforts to materialize, a continued decline in real US$48 per barrel in 2017 and US$51.4 in privatize state-owned enterprises and incomes could further undermine the 2018 and that the Kashagan offshore oil- improve the business climate. welfare of poor households. An increase field will commence production on sched- in targeted social transfers may be neces- ule. Rising oil output and an improving sary to mitigate the impact of inflation external environment are expected to contribute to a broad-based economic Risks and challenges and falling real incomes, but the key challenge will be to prioritize spending recovery, starting with the oil sector and on poor and vulnerable groups in order related services. However, sustaining Kazakhstan’s economic outlook is vulner- to maximize the impact of a limited fis- higher growth rates will depend on able to three main sources of downside cal envelope. TABLE 2 Kazakhstan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 5.8 4.1 1.2 0.1 1.9 3.7 Private Consumption 12.6 1.8 1.0 -2.0 1.5 4.5 Government Consumption 1.7 9.8 -1.3 4.2 0.9 3.0 Gross Fixed Capital Investment 4.9 4.4 -2.1 -5.6 7.9 4.8 Exports, Goods and Services 2.1 -3.2 -2.2 -2.1 2.1 2.5 Imports, Goods and Services 7.4 -4.0 -6.0 -5.0 1.9 5.4 Real GDP growth, at constant factor prices 5.4 3.9 1.0 0.2 1.8 3.7 Agriculture 11.2 1.3 4.4 3.5 3.5 3.5 Industry 3.1 1.5 -1.6 -1.2 1.6 2.6 Services 6.4 5.7 2.3 0.7 1.8 4.3 Inflation (Consumer Price Index) 5.8 6.7 6.6 13.7 4.5 4.4 Current Account Balance (% of GDP) 0.4 2.6 -2.9 -4.7 -1.5 -1.8 Financial and Capital Account (% of GDP) 2.6 2.5 8.1 12.4 8.7 7.8 Net Foreign Direct Investment (% of GDP) 3.3 2.1 2.3 4.3 4.2 4.0 Fiscal Balance (% of GDP) 3.6 0.0 -7.8 -4.8 -1.8 -1.6 Debt (% of GDP) 11.9 13.8 21.3 19.1 17.0 16.9 Primary Balance (% of GDP) 4.1 0.5 -7.2 -3.5 -1.4 -1.2 Poverty rate ($2.5/day PPP terms) a,b,c 0.4 0.4 0.4 0.4 0.4 0.3 Poverty rate ($5/day PPP terms) a,b,c 15.2 13.8 13.8 14.0 13.4 11.6 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 3-HB S. (b) P ro jectio n using neutral distributio n (2013) with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) P ro jectio ns are fro m 2014 to 201 8. MPO 55 Apr 16 Country Pages ●  91 While the poverty incidence among pub- KOSOVO Recent developments lic sector workers is low, public wage increases introduce distortions into the job market, constraining the ability of the In 2015 growth recovered to 3.6 percent, private sector to create jobs and address driven by domestic demand. This was the issue of high unemployment. Table 1 2015 primarily on account of a 147 percent The poverty headcount stood at 29.7 per- Population, million 1.8 increase in FDI that supported a pickup cent in 2011 based on national estimates. GDP, current US$ billion 6.4 in private investment across sectors, and Throughout the 2008-09 global economic GDP per capita, current US$ 3551 a 9 percent growth in remittances. An crisis, income growth of the bottom 40 a election-driven 25 percent increase in percent (B40) outpaced growth of the top School enrollment, primary (% gross) 98.3 public sector wages since April 2014 im- 60 percent (T60), driven primarily by in- Life Expectancy at birth, yearsa 70.5 pacted Q1 2015 growth. Stagnating ex- creases in earnings. Still, households, and Sources: World Bank WDI and M acro Poverty Outlook. ports, coupled with a positive growth in particularly those in the B40, remain con- Notes: (a) M ost recent WDI value (2013) imports, resulted in a negative net exports strained by very high dependency ratios – contribution to overall growth. the total economic dependency ratio (ratio External imbalances widened in 2015 with of the inactive population aged 15 and the current account deficit increasing to older and employment for ages 20-74) in 9.4 percent of GDP from 7.9 percent in Kosovo was 266 percent in 2014, com- 2014. The larger CAD is due to larger pared to 120 percent for EU28. profits recorded by foreign-invested com- Thanks to improved tax collection and panies; most of the profit was retained some expenditure cuts, fiscal stability Economic growth recovered in 2015 to rather than repatriated abroad and is returned and the fiscal deficit fell to 1.9 3.6percent, driven primarily by private therefore included in the financial account percent, of GDP in accordance with the under FDI. Deflation of 0.5 percent in fiscal rule that limits the deficit to 2 per- investment. Growth is projected to 2015, reflecting largely falling fuel and cent. Revenues grew by 9.4 percent, while strengthen to 4 percent a year in 2017 and food prices, helped support real house- expenditures increased by 8.5 percent, 2018, subject to political downside risks. hold incomes. which included a 16 percent increase in Incomes of low income households should Across sectors, growth picked up strongly transfers and an 8.2 percent increase in in 2015 in construction, and, to a lesser the wage bill due to Q1 impact of wage see a boost from a pick-up in growth in extent, in agriculture, both of which increases. Government debt increased by agriculture, agro-processing, and con- should boost incomes of low skilled 1.5 percent of GDP but remained low at struction, and from a steady inflow of re- households. However, there is no real 11.9 percent of GDP, with manageable mittances. However, growth so far has evidence yet of notable labor market im- servicing arrangements. The financial resulted in only limited employment crea- provements. According to the latest sector was profitable and stable, with (2014) data, youth unemployment is espe- growing credit and deposit (7.3 percent tion, which will continue constraining cially high at 61 percent. Almost three- and 6.4 percent), and, due to improved poverty reduction at home and support fourths of the unemployed are long-term. enforcement, a falling stock of NPLs pressure to seek employment abroad. About 10.7 percent of the working age (from 8.8 percent in February 2014 to 6.2 population were discouraged workers. percent in January 2016). FIGURE 1 Kosovo / Growth by components FIGURE 2 Kosovo / Unemployment statistics (2012-2014) Percent Percent 10 80 8 70 2012 2013 2014 6 60 4 50 2 40 0 30 -2 20 -4 10 -6 0 2012 2013 2014 2015 Unemployment rate Youth unemployment Long term Consumption Investments rate (15-24) unemployment rate Net exports Growth (12+ months) Sources: Statistics Agency of Kosovo and WB staff. Sources: Statistics Agency of Kosovo and WB staff. MPO 56 Apr 16 92  ●   World Bank ECA Economic Update April 2016 Poverty dynamics will be influenced by a of public investment and potential politi- Outlook number of factors. Growth in agriculture picked up in 2015 and should maintain cal and social unrest leading to lower FDI. Fiscal pressures resulting from reve- momentum during 2016-2017, boosted by nue, expenditure and regulatory side are Subject to political stability and planned recent reforms, as well as government also a risk. implementation of large investment pro- subsidies and donor grants such as the EU Lack of energy security remains a key jects, the economy is projected to grow at Instrument for Pre-Accession Assistance obstacle to attracting FDI, as well as con- 3.6 percent in 2016, driven by domestic (IPA II). With job creation, training, in- straining private sector participation, demand. Due to increased pensions of come source diversification, and support competitiveness, and having negative former contributors and inclusively to war for agri-processing among key focus areas social and health implications. Ensuring veterans, and higher remittances, the con- in the sector, the rural poor and B40 may energy affordability for low income tribution of consumption is expected to benefit from additional employment op- households will also be a challenge, as increase to 2.4 pp in 2016 and 2.7 pp in portunities and improvements in labor achieving cost recovery may require very 2017. Investment will continue to contrib- productivity. In the past, poverty and large increases in consumer prices; which ute positively through public spending on income dynamics have been strongly de- would require, in turn, substantial im- the highway to FYR Macedonia and pri- termined by labor earnings. The remain- provements to the social welfare infra- vate investment, including the Brezovica ing structural barriers like the inadequacy structure, primarily increasing coverage ski resort financed by foreign investors. of the education system, low ECE rates of the poor. The Stabilization and Association Agree- among low income households, make Addressing Kosovo’s vulnerabilities, high ment (SAA) with the EU, signed in 2015, rapid improvements in the labor market unemployment and poverty requires sig- should provide a further boost to FDI. The challenging, thus constraining future pov- nificant and far reaching structural re- current account deficit is expected to re- erty reduction. forms to boost economic growth and make main little changed at 9.6 percent of GDP. it more inclusive. The National Develop- The recent approval of the investment ment Strategy 2016-2021 provides some amendment to the fiscal rule will open up additional fiscal room for productive in- Risks and challenges direction on how to address key structural impediments and accelerate reforms. vestment in strategic sectors and boost public investments and economic growth The outlook is subject to downside risks in coming years. such as weaker than planned execution TABLE 2 Kosovo / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 3.4 1.2 3.6 3.6 4.0 4.1 Private Consumption 2 4.2 1.4 2.6 2.8 2.6 Government Consumption 3.3 19.1 -0.5 -0.2 -0.1 0 Gross Fixed Capital Investment -0.2 -11.1 4.1 1.4 1.4 1.8 Exports, Goods and Services 2.3 13.9 0.1 0.5 0.6 0.6 Imports, Goods and Services -1.5 5.0 -1.4 -0.7 -0.7 -0.7 Real GDP growth, at constant factor prices 3.4 1.2 3.6 3.6 4.0 4.1 Agriculture 0.2 0.1 0.7 0.6 0.8 0.7 Industry 1.5 0 0.4 0.9 0.9 0.4 Services 2.1 1.4 1.3 1.0 2.9 2.0 Inflation (Private Consumption Deflator) 2.4 0.3 -0.5 0.5 0.8 1.2 Current Account Balance (% of GDP) -6.5 -7.9 -9.4 -9.6 -9.8 -9.9 Fiscal Balance (% of GDP) -3.1 -2.6 -1.9 -1.8 -1.7 -2.0 Debt (% of GDP) 9.0 10.4 11.9 15.2 16.7 17.7 Primary Balance (% of GDP) -2.9 -2.4 -1.7 -1.5 -1.4 -1.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 57 Apr 16 Country Pages ●  93 in 2015 provided an important additional KYRGYZ Recent developments source of income for poor households. Strengthened social protection measures—including a 15 percent increase REPUBLIC A deteriorating external environment neg- atively affected the Kyrgyz economy in in the Guaranteed Minimum Income, which determines eligibility for the Bene- 2015. Exports and remittance inflows fell fit for Low-Income Families Program, and sharply, and gold output diminished. the establishment of a flat rate for pro- Table 1 2015 However, due to the strong performance poor transfers—boosted consumption Population, million 5.9 of the agricultural sector and robust con- among households in the bottom quintile GDP, c urrent US$ billion 6.6 struction activity supported by large-scale of the welfare distribution. However, low GDP per c apita, c urrent US$ 1109 public investment, the GDP growth rate rates of public spending on the benefit for Poverty rate ($2.5/day 2005PPP terms) a 29.2 slowed modestly from 4 percent in 2014 to low income families (0.5 percent of GDP Poverty rate ($5/day 2005PPP terms) a 83.9 3.5 percent in 2015. in 2014) limited the coverage of pro-poor Gini Coeffic ient a 26.8 Large central bank dividends and one-off transfers to less than one-third of the b 105.9 proceeds from a mining license sale boost- poorest quintile. Sc hool enrollment, primary (% gross) b ed nontax revenues to 8.1 percent of GDP. Life Expec tanc y at birth, years 70.0 Rising nontax revenues narrowed the fis- cal deficit from 3.9 percent of GDP in 2014 Outlook Sources: World Bank WDI and M acro Povert y Out look. Not es: (a) M ost recent value (2014) to 3 percent in 2015 even as capital invest- (b) M ost recent WDI value (2013) ment grew and tax revenues declined. Currency depreciation among the coun- GDP growth is projected to decelerate try’s main trading partners, coupled with marginally to 3.4 percent in 2016 as weak a decline in gold output, caused the som private demand negatively affects the to depreciate by 20 percent against the US agriculture, residential construction and In 2015 the Kyrgyz economy weathered dollar during 2015. Imports declined service sectors. Meanwhile, gold output the impact of a worsening external envi- markedly, narrowing the current-account will decline slowly and industry will ac- ronment relatively well, supported by deficit from 16.7 percent of GDP in 2014 to celerate due to the depreciation of the som strong agricultural output and increased 14.7 percent in 2015. Despite the deprecia- and the anticipated completion of several public spending. Growth is expected to tion, average annual inflation moderated large industrial projects. On the demand to 6.5 percent in 2015, reflecting lower side, private consumption growth is ex- remain sluggish in 2016 and 2017, with international food and fuel prices. pected to remain subdued, while imple- increased public investment only partially The poverty rate (measured at US$2.5 per mentation of the public investment pro- offsetting depressed private demand. The day, 2005 PPP terms) is estimated to have gram will boost demand for construction pace of poverty reduction is likely to slow fallen slightly in 2015, with improvements and related services. Rising public invest- in rural incomes and increases in social ment and full-year public sector wage in the short run. However, the economy is transfers mitigating the decline in real increases are expected to cause the fiscal anticipated to recover in 2018 as the ex- remittances and the impact of slowing job deficit to deteriorate to 7.4 percent of GDP ternal environment improves. growth in the service and construction in 2016. sectors. A 10 percent increase in pensions Given the high import content of large FIGURE 1 Kyrgyz Republic / Contribution to growth (in FIGURE 2 Kyrgyz Republic / GDP growth and actual and percentage points / percent) projected poverty rate 12 Percent of population Percent 10 60 12 8 50 10 6 8 40 4 6 30 2 4 0 20 2 -2 10 0 2013 2014 2015 2016 2017 2018 0 -2 Agriculture Industry w/out Kumtor 2006 2008 2010 2012 2014 2016 2018 Kumtor Construction Services GDP GDP growth, RHS $2.5/day PPP, LHS Source: Kyrgyz authorities. Sources: Kyrgyz authorities and WB staff calculations. MPO 58 Apr 16 94  ●   World Bank ECA Economic Update April 2016 infrastructure projects, the current- growth in the agricultural sector will slow than 6 percent, stress tests suggest that a account deficit is expected to widen to rural poverty reduction, though a gradual significant depreciation of the som or a 17.2 percent of GDP. With gold output recovery in remittances, which primarily crash in the real estate market could projected to decline further while pres- benefit poor rural households, could help threaten systemically important banks sure on regional currencies persists, the offset this effect. The overall poverty rate due to currency mismatches and the pos- som is expected to continue depreciating, is also expected to continue declining sible deterioration of portfolio quality. albeit at a more moderate pace. In this albeit at a slower pace, and is projected This would present the monetary au- context, the central bank is expected to to reach 28.6 percent in 2016 and 28.3 thorities with a difficult tradeoff be- maintain a conservative stance in order to percent in 2017. tween containing inflationary expecta- contain inflation. tions and allowing banks to rebuild their Looking forward, private sector and exter- balance sheets. nal demand are expected to recover but the fiscal stimulus to phase out and gold Risks and challenges Domestic challenges relate to the speed at which the Kyrgyz Republic will be able to output to decline further. As a result, leverage EEU accession to boost exports overall growth is projected to slow to 3.1 Exogenous regional developments are the and foster deeper regional trade integra- percent in 2017 before rebounding to 4.1 primary source of medium-term risk. The tion. Thus far, accession to the common percent in 2018 with internal and external pace of the recovery in Russia and Ka- market has not benefited Kyrgyz export- balances improving as public spending is zakhstan will affect the performance of ers to the extent anticipated due to higher curtailed. Likewise, the –hitherto pro- Kyrgyz exports, demand for Kyrgyz labor external tariffs on key textile inputs for the tracted- process of adapting national reg- and, to a lesser extent, foreign direct in- garment industry and strict application of ulations and systems to new Eurasian vestment inflows. Adverse exchange-rate EEU technical and phytosanitary regula- Economic Union (EEU) requirements developments could negatively impact tions at the Kazakh border. should allow Kyrgyz producers to gain domestic output growth through the fi- Given the limited fiscal space to increase greater access to the common market as nancial sector, and a further depreciation pro-poor transfers, further poverty reduc- the economies of Russia and Kazakhstan of the ruble could slow the pace of pov- tion will hinge on employment and wage begin to recover. erty reduction by eroding the real value of dynamics, especially in the formal private Limited fiscal space will preclude any ruble-denominated remittances. sector. Expanding job opportunities will significant increase in social spending, Although the Kyrgyz financial sector is require addressing barriers to formal sector though targeting improvements may en- well capitalized, and the share of nonper- employment and supporting the transition hance expenditure efficiency. Moderate forming loans remains manageable at less of workers away from informal activities. TABLE 2 Kyrgyz Republic / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 10.9 4.0 3.5 3.4 3.1 4.1 Private Consumption 8.0 3.0 0.2 1.9 2.7 3.4 Government Consumption -0.4 -0.5 6.4 2.6 -4.5 -1.6 Gross Fixed Capital Investment 1.3 17.4 2.3 7.6 5.5 5.5 Exports, Goods and Services 12.3 -6.2 -5.3 2.0 5.6 7.8 Imports, Goods and Services 4.1 1.6 -9.0 1.8 3.0 4.1 Real GDP growth, at constant factor prices 10.9 4.1 3.5 3.4 3.0 4.0 Agriculture 2.6 -0.6 6.2 2.5 2.5 3.0 Industry 30.5 5.1 -4.2 2.6 6.4 9.1 Services 11.5 6.6 4.2 4.1 2.5 3.2 Inflation (Consumer Price Index) 6.6 7.5 6.5 6.5 6.5 6.0 Current Account Balance (% of GDP) -15.0 -16.7 -14.7 -17.2 -12.9 -11.4 Financial and Capital Account (% of GDP) 14.4 8.8 14.5 14.0 17.1 15.3 Net Foreign Direct Investment (% of GDP) 8.5 2.3 8.9 8.7 7.1 6.8 Fiscal Balance (% of GDP) -3.7 -3.9 -3.0 -7.4 -4.6 -2.0 Debt (% of GDP) 46.1 52.6 68.8 71.7 73.3 72.0 Primary Balance (% of GDP) -2.9 -3.0 -2.0 -6.6 -3.6 -0.8 Poverty rate ($2.5/day PPP terms) a,b,c 35.8 29.2 28.9 28.6 28.3 27.9 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 0-KIHS and 201 4-KIHS. (b) P ro jectio n using annualized elasticity (201 0-201 4) with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) A ctual: 201 3, 2014. P ro jectio ns are fro m 2015 to 2018. MPO 59 Apr 16 Country Pages ●  95 exports going to Germany (mainly auto- MACEDONIA Recent developments mobile parts). Imports expanded driven by FDI, suggesting a solid export growth in the coming period. The current account FYR FYR Macedonia’s economy is estimated to have expanded 3.7 percent in 2015. deficit widened to 1.4 percent of GDP from 0.8 percent in 2014 despite the nar- Growth was mainly driven by construc- rower trade deficit, driven by a lower sur- tion, wholesale and retail trade and ser- plus in the income accounts. Private trans- Table 1 2015 vices, particularly real estate and financial fers were slightly lower than in 2014, but Population, million 2.1 services. Manufacturing activities con- covered the trade deficit, alleviating exter- GDP, c urrent US$ billion 10.1 tracted in the first half of 2015, but partial- nal financing pressures. Higher outflows GDP per c apita, c urrent US$ 4845 ly recovered in the second half of the 2015. of FDI were registered in 2015, likely relat- a 12.7 On the demand side, growth was largely ed to the political uncertainties, resulting Poverty rate ($2.5/day 2005PPP terms) a driven by private consumption pushed up in slightly lower net FDI inflows com- Poverty rate ($5/day 2005PPP terms) 34.3 by growing employment, higher real wag- pared to 2014. a Gini Coeffic ient 36.0 es, pensions and social transfers, likely The financial sector remained sound. b Sc hool enrollment, primary (% gross) 89.3 related to the expectations of upcoming Credit growth reached 9.5 percent (y-o-y) Life Expec tanc y at birth, years b 75.0 elections. Government consumption of in 2015 largely driven by household lend- Sources: World Bank WDI and M acro Poverty Outlook. goods and services also increased sharply ing. Non-performing loans fell to 10.6 Notes: by 23 percent in the second half of the percent in December. The banking sector (a) M ost recent value (2013) year. Gross investments rebounded in the remains profitable, highly liquid and well- (b) M ost recent WDI value (2013) second of 2015, after a sharp decline in the provisioned. While household debt is still second quarter of the year. The recovery moderate (22.2 percent of GDP), the cen- supported by publicly financed construc- tral bank acted cautiously and introduced FYR Macedonia’s economic growth re- tion of new highways and FDI. prudential measures to slow the expan- Deflationary pleasures persisted. Falling sion of consumption-related credit and mained robust at 3.7 percent in 2015, despite global oil prices led to deflation of 0.3 per- encourage corporate lending. the political turmoil. Growth was driven by cent in 2015, the same as in 2014, benefit- The fiscal deficit narrowed in 2015, helped private consumption, supported by higher ing people at the bottom of the income by the deferment of pension transfers to employment, wages, and pensions, and by distribution who spend a larger share of January 2016. Total revenues increased to government spending, which increased 23 their income on food. Twelve-month core 28.8 percent of GDP driven by the re- inflation remained positive at 0.5 percent. introduction of a profit tax on earnings percent in the second half of 2015. Invest- Exports grew faster than imports in 2015, that were not reinvested (not collected ment also expanded, driven by FDI and pub- further narrowing the trade deficit. Export since 2009), and by higher social contribu- lic works. Positive economic and labor mar- growth was largely driven by FDI-related tions linked to improvements in the labor ket developments supported a gradual reduc- exports (40 percent of overall exports). markets. Expenditures also increased, but Exports of “traditional” products such as less than revenues and stood at 32.3 per- tion in poverty. Growth is expected to accel- iron and steel, ores and slag, and tobacco cent of GDP largely reflecting higher pub- erate during the forecasting period, with declined. Export destinations became lic wages, pensions, social transfers, and positive spillovers to poverty reduction. more concentrated with 44 percent of spending on goods and services FIGURE 1 Macedonia FYR / GDP growth decomposition FIGURE 2 Macedonia FYR / Actual and projected poverty rates and GDP per capita in percent Poverty Rate GDP per 15 (%) capita 45 16000.0 10 40 14000.0 35 12000.0 5 30 10000.0 0 25 8000.0 20 -5 6000.0 15 10 4000.0 -10 5 2000.0 -15 0 0.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Final consumption Gross capital formation 2009 2011 2013 2015 2017 Net exports Real growth $2.5/day PPP $5/day PPP GDP per capita Sources: FYR Macedonia State Statistics Office and World Bank staff calculations. Source: World Bank (see notes to Table 2). MPO 62 Apr 16 96  ●   World Bank ECA Economic Update April 2016 (especially in the second half of 2015). The Long-term unemployment remains elevat- and social transfers. Large FDI-related central government deficit reached 3.5 ed, at 61 percent of total unemployment. exports are likely to be accompanied by percent of GDP in 2015, lower than 2014 Poverty is expected to have continued to higher imports associated with investment (4.2 percent) and the revised budget for decrease in 2015, on account of the better projects, leading to a relatively small con- 2015 (3.7 percent), but higher than the labor market outcomes and higher gov- tribution from net external demand. Pov- level proposed in the Medium Term Fiscal ernment transfers. Using the US$5/day erty is expected to continue its downward Strategy 2015-2017 (3.4 percent of GDP). and $2.5/day lines (2005 PPP), poverty trend on account of increases in employ- The difference between actual and revised rates were estimated at 34.3 and 12.7 in ment in construction, pensions and social budget deficits reflect contributions by the 2013, following a decreasing trend pre- transfers. state funded pension fund to the private sent at least since 2009, the earliest for funds (around 0.1 percent of GDP) related when comparable data is available. In to 2015, but differed to January 2016. Public debt continued to increase in 2015, 2014-2015, higher real wages and employ- ment opportunities created in construc- Risks and challenges but remains below the regional average at tion, manufacturing and services are ex- 46.4 percent of GDP. In addition to the pected to have contributed to further re- The political situation remains the prima- fiscal deficit, state guarantees associated ductions in poverty. Slightly lower pri- ry downside risk to the economy in the with large investment projects also con- vate transfers in 2015 should have had near term. Prolonged political uncertain- tributed to the increase. While the public only a negligible effect on poverty, com- ties could affect investment decisions and debt is still moderate, it has increased fast pared to that coming from falling prices slow down economic activity. The escala- in the last five year (by 20 p.p. of GDP). and higher social transfers. tion of the current refugee crisis also poses Continuing this trend could pose risks to a downside risk, especially if the EU de- the economy. cides to close its borders or significantly Unemployment declined supported by widespread job creation. Employment Outlook limit the inflow. Medium term challenges include the need grew in manufacturing, public admin- for fiscal consolidation and prioritization istration, services, and construction. Labor Growth is expected to stay at 3.7 percent of public spending and further improving force participation remained stable, lead- in 2016 and accelerate to 4 percent in 2017 labor market outcomes to improve growth ing to a decline in unemployment from and 2018, led by public investment in two elasticity of poverty reduction. 28.1 percent in 2014 to 26.1 percent in major highways as well as by strong FDI. Limited access to microdata and an out- 2015. Youth unemployment, at 47.3 per- Private consumption is expected to re- dated census limit the ability to track and cent, dropped significantly in 2015 helped main robust supported by further increas- benchmark improvements in living condi- by public youth employment programs. es in employment, public wages, pensions tions in a timely manner. TABLE 2 Macedonia FYR / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 2.9 3.5 3.7 3.7 4.0 4.0 Private Consumption 1.9 2.1 3.2 3.4 3.6 3.6 Government Consumption 0.5 1.0 4.6 4.6 4.0 2.3 Gross Fixed Capital Investment 1.9 6.9 0.3 5.1 7.1 8.3 Exports, Goods and Services 6.1 18.2 4.6 7.7 8.2 7.8 Imports, Goods and Services 2.2 16.0 2.4 6.8 7.5 7.3 Real GDP growth, at constant factor prices 4.4 6.5 4.5 3.9 3.8 4.1 Agriculture 8.6 2.2 -0.7 0.0 1.0 1.0 Industry 7.6 11.8 7.8 6.0 4.8 4.9 Services 2.6 5.0 3.9 3.4 3.7 4.1 Inflation (Consumer Price Index) 2.8 -0.1 0.0 0.9 1.6 2.0 Current Account Balance (% of GDP) -1.6 -0.9 -1.4 -1.7 -2.1 -2.6 Financial and Capital Account (% of GDP) 1.5 0.5 1.1 2.0 3.1 4.1 Net Foreign Direct Investment (% of GDP) 2.8 2.3 1.9 2.1 2.5 2.7 Fiscal Balance (% of GDP) -4.0 -4.2 -3.5 -3.4 -3.0 -2.7 Debt (% of GDP) 34.0 38.2 37.9 39.9 41.1 41.7 Primary Balance (% of GDP) -3.1 -3.2 -2.3 -2.1 -1.8 -1.6 Poverty rate ($2.5/day PPP terms) a,b,c 12.7 12.1 11.6 11.1 10.5 9.9 Poverty rate ($5/day PPP terms) a,b,c 34.3 32.8 31.4 30.0 28.6 27.2 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n gro uped-data fro m SILC harmo nizatio n, using 201 4-SILC (survey year) (b) P ro jectio n using neutral distributio n (2013) with pass-thro ugh = 1based o n GP D per capita co nstant P P P . (c) P ro jectio ns are fro m 2014 to 201 8. MPO 63 Apr 16 Country Pages ●  97 to freeze procurement of goods and ser- MOLDOVA Recent developments vices, and to ration capital expenditures. As a result, the government maintained the real value of social spending, while capital The economy flipped into recession in the expenditures faced a double-digit decline. second half of 2015 due to a drought, The cash deficit increased to 2.2 percent of Table 1 2015 weak external flows, repercussions of a GDP, from 1.7 percent a year ago. Population, million 3.5 large scale bank fraud, and tight monetary The already poor performing labor market GDP, c urrent US$ billion 6.5 policy. Amid political instability since remained weak in 2015. Unemployment GDP per c apita, c urrent US$ 1828 2014 and bank fraud, the economy grew increased in three out of four quarters, Poverty rate ($2.5/day 2005PPP terms) a 2.9 3.6 percent in the first half of 2015. How- ending at 4.2 percent by the end of 2015. a ever, severe drought and weaker domestic Employment did not catch up with the Poverty rate ($5/day 2005PPP terms) 40.7 activity, reflecting tighter monetary policy increase in the labor force, around 3 per- Gini Coeffic ient a 26.8 and fiscal squeeze, offset the positive con- cent, likely due to the return of people b Sc hool enrollment, primary (% gross) 93.8 tribution from net exports. As a result, real working abroad. Average earnings in 2015 Life Expec tanc y at birth, years b 68.7 GDP declined 0.5 percent in 2015. After increased slightly in real values (0.7 per- Sources: World Bank WDI and M acro Poverty Outlook. the government guaranteed deposits in 3 cent), probably stemming from an in- Notes: insolvent banks with a total cost of 12 per- crease in self-employment earnings in the (a) M ost recent value (2014) (b) M ost recent WDI value (2013) cent of GDP, monetary policy responded non-agricultural sector, counterbalancing aggressively to higher inflation. The Na- the decline in households’ income from tional Bank raised the base interest rate to employment and agriculture. a record high of 19.5 percent, virtually A severe summer drought, lower remit- stopping credit growth. Twelve-month tances and higher inflation are estimated The Moldovan economy moved into reces- inflation almost doubled to 9.7 percent on to have affected living standards in Mol- average in 2015, nonetheless. Remittances dova in 2015, pushing poverty into an sion in the second half of 2015 driven by dropped sharply in 2015, leading to an upward trend. Poverty had been on the weaker external flows, large scale bank expansion of the current account deficit to decline for recent years, going from 46.4 fraud, tighter monetary policy and a 8.5 percent of GDP from 7.1 percent in percent of the population in 2012 (US$5 drought. Poverty is estimated to have 2014. Foreign reserves stabilized after a per day, 2005 PPP) to an estimated 40.7 drop in the first quarter of 2015, settling to percent in 2014. However, developments slightly increased with weak labor mar- the equivalent of 3 months of imports. throughout the year 2015 are estimated kets failing to contribute to raising living Confronted with lower revenues and fi- to have halted this downward trend, standards. Economic growth and poverty nancing in 2015, the government adjusted with poverty estimated to stand at 41.9 reduction will remain stagnant in 2016, expenditures while prioritizing social pay- percent in 2015. In addition to the impact with an expected recovery in 2017 as in- ments. Reflecting a weaker economy, high of a severe summer drought on the agri- interest rates and lower external grants, cultural sector, in which many poor are vestment confidence increases. Fiscal con- revenues dropped 6.2 percent in real concentrated, the decline in remittances solidation is needed while ensuring that terms. Expenditure increased 4.5 percent, may have pushed some into poverty and poverty gains are not further eroded. but were 6.9 percent below planned levels. increased the depth of poverty for the Since June 2015, the Government has had already poor. Although only 27 percent FIGURE 1 Moldova / Real GDP and current account projections FIGURE 2 Moldova / Actual and estimated poverty rates and GDP per capita (PPP) % of GDP Poverty Rate (%) GDP per capita 100 6,000 7 90 5,000 80 2 70 4,000 60 -3 50 3,000 40 2,000 30 -8 20 1,000 10 -13 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 $2.5/day PPP $5/day PPP Real GDP, % change Current Account Balance, % GDP GDP per capita PPP Sources: National authorities and WB's projections. Sources: World Bank (see notes to Table 2). MPO 64 Apr 16 98  ●   World Bank ECA Economic Update April 2016 of the non-poor received remittances, could affect households through other stabilization. Major efforts in regaining the those who do are highly dependent on fronts. Poverty is expected to stand at 41 efficiency and credibility of the banking them, with remittances accounting for 55 percent in 2016. sector, fighting corruption and dealing with percent of their income. Furthermore, 15 As the economy stabilizes and investor governance issues are needed to regain in- percent of the poor derive more than half confidence improves, Moldova is expected vestor and consumer confidence. of their income from remittances. slowly to regain its growth momentum Moldova faces a need for fiscal consolida- reaching its full potential by 2017-2018; tion to maintain fiscal sustainability, slight reductions in poverty may follow. while protecting the less well-off. A Outlook As inflationary pressures dissipate, con- sumer prices are projected to decrease to weaker economy, high interest rates, the fiscal cost of the failed banks and lower the central bank’s inflation target range of external financing exacerbate the immedi- The economy is projected to remain sub- 5±1.5 percent starting in 2017. Along with ate fiscal pressures stemming from index- dued in 2016, with growth close to nil. Net the economic recovery, fiscal deficits are ation of social payments. With higher exports are expected to be the main likely to decline to 2.5 percent of GDP by projected public debt and lower external growth driver given the exchange rate 2018. Weaker domestic activity will keep grants and financing, Moldova should adjustment and tighter domestic demand the current account deficit on a gradually concentrate on efficiency gains in public policies. Prolonged low remittances and declining path. The acceleration in growth recurrent expenditure and improve gov- higher costs of domestic financing cou- is expected to be accompanied by a reduc- ernance. This process needs to take ac- pled with lack of investor confidence after tion in poverty to 37.5 percent in 2017 and count of the distributional impacts that the fraud in the banking system will con- could reach 33.4 percent in 2018. fiscal measures – either on the revenue or strain domestic absorption. The budget the expenditure side - may have, particu- deficit is expected to increase to 3.2 per- larly on the less well-off. cent of GDP in 2016. Accordingly, poverty is expected to decline Risks and challenges Moving forward, strengthening labor markets is critical for growth and pov- only modestly in 2016, by less than one erty reduction. Promoting a sound busi- percentage point. Remittances are likely to Moldova has limited macroeconomic buffers ness environment and improving gov- remain at lower levels, inflationary pres- and needs to deal with major governance ernance are necessary steps to boost job sures remain and a recovery in labor mar- issues. A flexible exchange rate will help creation and open up opportunities in kets is not expected in the short term. Alt- mitigate some of the shocks, but efficient the labor market. hough fiscal policies have protected social public spending and institutions are the payments, the overall limited fiscal capacity most important elements of macroeconomic TABLE 2 Moldova / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 9.4 4.8 -0.5 0.5 4.0 4.5 Private Consumption 6.4 3.2 -2.3 -0.7 3.2 3.4 Government Consumption -0.1 0.1 0.0 -0.7 2.0 1.7 Gross Fixed Capital Investment 3.8 10.0 -1.2 -1.5 4.3 5.1 Exports, Goods and Services 9.6 1.0 2.3 1.2 3.2 5.8 Imports, Goods and Services 4.4 0.4 -4.3 0.1 3.8 4.9 Real GDP growth, at constant factor prices 10.6 5.4 -0.4 0.7 3.8 4.5 Agriculture 46.6 8.5 -13.4 7.8 5.3 5.4 Industry 7.6 7.5 -1.4 0.2 4.9 5.6 Services 2.5 3.8 4.6 -1.4 3.0 3.9 Inflation (Consumer Price Index) 4.6 5.1 9.7 8.9 5.4 4.8 Current Account Balance (% of GDP) -6.4 -7.1 -8.1 -7.7 -7.4 -7.1 Financial and Capital Account (% of GDP) 5.3 8.2 9.4 8.7 8.3 7.9 Net Foreign Direct Investment (% of GDP) 3.1 3.9 4.5 4.4 4.8 5.0 Fiscal Balance (% of GDP) -2.0 -1.9 -2.3 -3.2 -2.5 -2.1 Debt (% of GDP) 31.7 32.5 44.7 45.8 45.1 44.7 Primary Balance (% of GDP) -1.3 -1.2 -1.3 -2.0 -1.3 -1.0 Poverty rate ($2.5/day PPP terms) a,b,c 3.8 2.9 3.1 2.9 2.1 1.5 Poverty rate ($5/day PPP terms) a,b,c 39.6 40.7 41.9 41.0 37.5 33.4 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 4-HB S. (b) P ro jectio n using neutral distributio n (201 4) with pass-thro ugh = 1 based o n GDP per capita co nstant P P P . (c) A ctual: 201 3, 2014. P ro jectio ns are fro m 2015 to 2018. MPO 65 Apr 16 Country Pages ●  99 of employing available local labor from MONTENEGRO Recent developments the unemployment bureau—aims to pro- tect domestic workers but may have im- pacts on firms’ efficient use of labor and Real GDP is estimated to have expanded competitiveness. Further, the amendments by 3.4 percent in 2015, up from 1.8 percent to the Law on Social and Child Care intro- Table 1 2015 in 2014, fueled by exports of services and duced lifetime benefit for women giving Population, million 0.6 investments in tourism and the Bar- birth to three or more children in the GDP, c urrent US$ billion 4.0 Boljare highway section. Positive econom- amount of 70 percent of the average net GDP per c apita, c urrent US$ 6427 ic growth since 2013 has increased em- salary, under the condition of 25 years of Poverty rate ($2.5/day 2005PPP terms) a 1.0 ployment, including in low-skilled sectors service or 15 years for mothers of three or a such as construction and administrative four and more children, respectively. Poverty rate ($5/day 2005PPP terms) 13.3 a and support services. Gross wage increas- Women with this right are also entitled to Gini Coeffic ient 31.9 es in agriculture, construction and tourism health insurance. This is likely to trigger b Sc hool enrollment, primary (% gross) 100.9 in 2015 were among the highest across worsening of an already low female labor Life Expec tanc y at birth, years b 74.6 sectors. This composition of growth and participation rate. Additionally, the fiscal Sources: World Bank WDI and M acro Poverty Outlook. employment expansion, at least in the impact of this policy is assessed at 1 per- Notes: short run, has been in general beneficial cent of GDP. Overall poverty trend closely (a) M ost recent value (2014) (b) M ost recent WDI value (2013) for improving welfare of the poor. mirrors labor market performance, espe- The labor market has been mostly improv- cially employment in low-skill sectors. ing, though structural issues remain. The With continued economic recovery in- four-quarter average unemployment rate cluding in these sectors, poverty Economic growth is expected to remain fell to 17.6 percent in September 2015 from (measured at the regional poverty line of robust in 2016 driven by the Bar-Boljare its peak of close to 20 percent in 2012. Ac- US$5 in 2005 PPP) has declined from its tivity and employment rates rose from 50 peak at 19.2 percent in 2012 to an estimat- highway construction as well as tourism percent and 40.1 percent, respectively, in ed 11.9 percent in 2015. projects. With labor market improve- 2012 to 55 per-cent and 45.9 percent, re- External imbalances narrowed in 2015 on ments, especially in low-skilled sectors, spectively in Q3 2015, surpassing 2008 the back of strong tourism performance poverty is estimated to have declined levels. However, they remained very low (receipts up by 19 percent y-oy), while compared to EU peers due to structural goods export continued to struggle given steadily since its peak in 2012. Unem- factors such as the incomplete economic the narrow export base of Montenegro. ployment remained high and labor force transition, labor mismatches and high The current account deficit (CAD) de- participation low, however. Capital in- reservation wages. While the unemploy- clined to 13.4 percent of GDP from 15.2 vestment along with the revenue under- ment rate for most workers went down percent in 2014. The still high CAD was performance pushed the fiscal deficit to 7 over the last two years (until September financed by robust net inflows of FDI 2015), older workers aged 50-64 experi- (mostly in banking and real estate) which percent of GDP and public debt to 68 enced a slight increase. The new 2015 law surged to 17.2 percent of GDP in 2015. percent of GDP. External debt remained on foreign workers--which further limits Lending gradually recovered in 2015 with elevated despite strong FDI inflows. quotas of work permits for foreign work- strong growth of the deposit base driven ers and introduces the strict requirement mostly by corporate sector. The share of FIGURE 1 Montenegro / Contributions to annual GDP FIGURE 2 Montenegro / Actual and estimated poverty rates growth and GDP per capita (PPP) Percent Poverty Rate (%) 30 GDP per capita (USD PPP) 25 18,000 16,000 20 14,000 10 12,000 15 10,000 8,000 -10 10 6,000 5 4,000 2,000 -30 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016f 0 0 Final consumption Gross fixed capital formation 2005 2007 2009 2011 2013 2015 2017 Change in inventories Net exports $2.5/day PPP $5/day PPP Residual item GDP growth GDP per capita PPP Sources: World Bank. Sources: World Bank (see notes to Table 2). MPO 66 Apr 16 100  ●   World Bank ECA Economic Update April 2016 non-performing loans declined from 15.9 infrastructure (highway and energy) and expected to widen to 15 percent of GDP and percent at the end of 2014 to 12.5 percent tourism. Improvement in the labor mar- external debt exceeding 140 percent of GDP in 2015, partially due to a sale of non- ket, led by new employment in services, in the projection period. performing assets to factoring companies. but also the government's plan to increase However, despite a surge in the number public sector wages, pensions, and some of banks to 15 in 2015 from 12 in 2014 and record low rates in the eurozone, the inter- social benefits in 2016, will boost private consumption and contribute to further Risks and challenges est rates margins remained high and the poverty reduction. Welfare gains through bank profitability low on average. employment in highly cyclical sectors are, Risks to the outlook remain tilted to the After consolidation measures reduced the however, volatile for the bottom income downside. Slower or stagnating growth in fiscal deficit to 3.1 percent of GDP in 2014, quintiles. Poverty measured at US$5 in the Euro area, as well as financial market a rise in capital (highway-related) expend- 2005 PPP is expected to decline further to volatility present the main external risks itures along with the revenue underper- 9.0 percent by 2017, though with high for budget financing and growth pro- formance increased the fiscal deficit to 7 vulnerability to macro risks. spects. The large share of debt denominat- percent of GDP in 2015. As expected, pub- Fiscal policy will remain expansionary in ed in US dollars (in 2014 the equivalent to lic debt continued its upward trend to 2016-18 with the 2016 deficit projected at EUR688 million of the highway loan) and close to 68 percent of GDP in 2015. This 6.2 percent of GDP. The government plans the large borrowing needs over the medi- macro-fiscal framework led the Standard to allocate as much as 9 percent of GDP um term presents substantial risks to pub- & Poor's to affirm Montenegro's long-term for capital investments, with public debt lic finances. The geopolitical tensions are and short-term B+/B ratings with stable expected to rise to 72.3 percent of GDP in not expected to have direct impacts on the outlook. In early March, the government 2016. The borrowing requirement in 2016 Montenegrin economy. Risks on the do- issued EUR300 million 5-year Eurobond at is around 18 percent of GDP to repay the mestic side include delays in the imple- a coupon of 5.75 percent, almost two per- Eurobond coming for redemption and mentation of needed structural reforms to centage points above the last issue. finance the budget deficit. Deficits for 2017 stabilize public finances and increase com- -2018 have also been raised upward from petitiveness ahead of the general elections the earlier estimates presented in the Sep- set for the autumn of 2016. This could Outlook tember 2015 Fiscal Guidelines; the govern- ment now is not planning to eliminate reduce foreign investors’ confidence and their investments in Montenegro. House- primary deficit by 2018. hold welfare gains continue to be highly The economy is estimated to grow by 3.3 Rising highway-related imports is likely to vulnerable to macro risks and the associat- percent a year on average over the medi- deepen already large external vulnerabili- ed volatility in the labor market. um term driven by investment in public ties with the current account deficit in 2016 TABLE 2 Montenegro / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 3.5 1.8 3.4 3.7 3.1 3.0 Private Consumption 1.6 2.9 1.4 1.1 2.3 2.5 Government Consumption 1.3 1.4 -3.0 3.2 0.0 1.7 Gross Fixed Capital Investment 10.7 -2.5 23.2 11.6 2.8 -1.8 Exports, Goods and Services -1.3 -0.7 6.5 1.7 2.0 2.2 Imports, Goods and Services -3.1 1.6 2.0 2.3 -0.4 -1.5 Real GDP growth, at constant factor prices 4.1 1.9 3.4 3.7 3.1 3.0 Agriculture 13.6 1.8 3.2 3.3 2.1 2.1 Industry 4.3 4.5 5.8 4.7 3.5 3.5 Services 2.4 0.8 2.4 3.3 3.1 2.9 Inflation (Private Consumption Deflator) 1.9 -1.0 1.6 1.7 1.9 1.5 Current Account Balance (% of GDP) -14.5 -15.2 -13.4 -14.2 -14.9 -15.2 Financial and Capital Account (% of GDP) 7.0 3.6 3.3 10.3 11.1 11.6 Net Foreign Direct Investment (% of GDP) 9.6 10.2 17.2 11.0 11.2 10.8 Fiscal Balance (% of GDP) -4.6 -3.1 -7.0 -6.2 -6.4 -5.6 Debt (% of GDP) 57.5 59.9 68.0 72.3 76.4 78.6 Primary Balance (% of GDP) -2.4 -0.8 -4.7 -4.1 -3.8 -3.1 Poverty rate ($2.5/day PPP terms) a,b,c 2.7 1.0 1.0 0.8 0.8 0.7 Poverty rate ($5/day PPP terms) a,b,c 18.7 13.3 11.9 11.1 9.0 8.5 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 4-HB S. (b) P ro jectio n using neutral distributio n (201 4) with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 3, 2014. P ro jectio ns are fro m 2015 to 2018. MPO 67 Apr 16 Country Pages ●  101 Moderate poverty is expected to have POLAND Recent developments declined from 5.1 percent in 2012 to 4.4 percent in 2015 using the $5.00/day 2005 PPP poverty line, in line with in- Economic growth picked up to 3.6 per- creases in private consumption and cent in 2015 from 3.4 percent in 2014 on higher employment. Table 1 2015 the back of robust private and public The general government deficit is esti- Population, million 38.0 consumption, investment, and a slightly mated to have declined to 3.0 percent GDP, c urrent US$ billion 475.8 positive contribution from net exports. of GDP in 2015 from 3.3 percent in 2014 GDP per c apita, c urrent US$ 12518 The latter has been sustained by the owing to a rebound in direct taxes, in Poverty rate ($2.5/day 2005PPP terms) a 0.9 weaker Zloty, cheap oil, and a gradual line with strong labor market perfor- a rebound in import demand from West- mance. Public debt to GDP ratio in- Poverty rate ($5/day 2005PPP terms) 5.1 a ern Europe. Private consumption contin- creased in 2015 to 51.1 percent, up from Gini Coeffic ient 33.1 ued to benefit from higher real disposa- 50.4 percent of GDP in 2014. Prudent b Sc hool enrollment, primary (% gross) 101.2 ble incomes as a result of improved labor fiscal management of local govern- Life Expec tanc y at birth, years b 76.8 market conditions in 2015 characterized ments which reportedly recorded a sur- Sources: World Bank WDI and M acro Poverty Outlook. by a solid 4.2 percent growth of average plus of 0.3 percent of GDP contributed Notes: nominal wages and its even higher in- to these results. (a) M ost recent value (2012) (b) M ost recent WDI value (2013) crease in real terms due to negative infla- Favorable financing conditions have tion of 0.9 percent and relatively strong supported credit growth, but the bank- household credit growth. ing sector faces new challenges. The Employment continued to grow by strengthening of the Swiss Franc has around 1 percent in 2015 and the LFS affected about 575,000 families holding Growth picked up in 2015 driven mainly unemployment rate fell to 6.9 percent, a mortgages denominated in the SFR, by domestic demand. Private consump- level not seen since 2008. Employment leading the new President to propose growth was dominated by workers with measures to convert them into zlotys at tion was bolstered by improving labor tertiary education, with modest gains a loss for the banks. This, compounded market conditions and negative consumer among employees with secondary educa- by the introduction of a new tax on price inflation due to lower energy prices. tion and job cuts among low skilled bank assets, has led to concerns over We project Poland’s growth to strengthen workers. After two years when virtually bank profitability. Poland’s external all new employment has been in the position has strengthened in 2015 and from 3.6 percent in 2015 to 3.7 percent in form of temporary contracts (both Labor trade of goods recorded a surplus of 0.8 2016 but moderate slightly in the years Code and Civil Contracts), new perma- percent of GDP, after decades of persis- beyond in line with the weaker outlook for nent jobs dominated in 2015. This posi- tent deficit. At the same time, the cur- the Eurozone. The new government tar- tive change reflected an improved bar- rent account deficit narrowed from 2 gets a more dynamic and more inclusive – gaining position of employees during percent in 2014 to 0.5 percent of GDP the economic upturn and the anticipat- only in 2015. Gross external debt (72.3 spatially as well -- economic growth and ed forthcoming regulatory changes percent of GDP in the 3 rd quarter of recently announced a comprehensive re- making ‘junk contacts’ less appealing 2015) stabilized at its end 2014 level form plan to boost investment. for employers. (72.4 percent of GDP). FIGURE 1 Poland / Contributions to annual GDP growth FIGURE 2 Poland / Actual and estimated poverty rates and GDP per capita (PPP) percent Poverty Rate (%) GPD per 10 capita PPP 20 30,000 8 18 25,000 6 16 14 4 20,000 12 2 10 15,000 0 8 10,000 6 -2 4 5,000 -4 2 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 0 0 Final consumption Gross Fixed Investment 2004 2006 2008 2010 2012 2014 2016 2018 Statistical Discrepancy Change in inventories $2.5/day PPP $5/day PPP Net exports GDP growth GDP per capita PPP Sources: World Bank team estimates based on Central Statistical Office. Sources: World Bank (see notes to table 2). MPO 68 Apr 16 102  ●   World Bank ECA Economic Update April 2016 robust economic performance, we expect Outlook a deterioration of the structural fiscal deficit. This is mainly due to the intro- Risks and challenges duction of the Family 500+, which is ex- The outlook remains favorable as real pected to increase spending by about 1 Despite the relatively benign economic fore- GDP is projected to increase by 3.7 percent percent of GDP in 2016. This will be cast, the balance of risks remains skewed to in 2016 and 3.5 percent in 2017-18 even as funded through the new taxes on finan- the downside. External challenges result economic prospects for the euro area cial institutions and retail sales (yielding from geopolitical tensions and economic moderate. In 2016, private consumption is about 0.3 percent of GDP) and receipts of slowdown in large emerging markets. set to become an even more dominant 0.5 percent of GDP from the sale of LTE There are three main internal risks. growth driver, supported by further im- frequency, and some improvements in First, the fiscal deficit in 2017 and years be- provements in the labor market and an VAT tax compliance. In recent months, yond may exceed the 3 percent of GDP if increase in government transfers, notably the Government undertook decisive ef- larger public spending is accompanied with a new generous child benefit, the Family forts to reduce huge tax gaps in VAT gradual improvements in tax compliance. 500+. Investment is expected to grow and CIT. Second, the proposed return to a lower moderately as a result of high capacity The fiscal outlook beyond 2016 is uncer- retirement age weaken fiscal sustainability utilization and low interest rates. tain, our baseline path shows an increase in the long term. Third, the solution to the Further declines in poverty incidence are in the deficit to 3.3 percent of GDP in 2017. legacy of Swiss Franc denominated mort- expected in 2016 as growth in employment However, the outcome will depend on the gages proposed by the President office and real wages. More importantly the in- recent government proposals which could could significantly affect bank profitability troduction of the new family benefit pro- further increase the deficit, including a if not the soundness of the financial system. gram is expected to lead to increases in higher tax-free threshold for the personal Poland’s challenge is to accelerate indu- disposable incomes and a significant re- income tax, lowering the retirement age, cive growth with an aging society. There duction in poverty. Financial support for or a return to the standard VAT rate of is a need to improve enabling regulatory the elderly and more generous pensions’ 22% from the current 23% rate. environment. This can be supported by indexation should continue this trend into In mid-February, the authorities an- policies removing barriers for investment 2017. The $5.00/day 2005 PPP poverty rate nounced the ‘Program for Responsible and by investment in people to raise skills. is projected to decline to 2.8 percent in 2016 Development,’ which presents a medium- There is a scope to upgrade aging infra- and then further to 2.6 percent in 2017. term reform agenda. The program has five structure, in particular in the energy sec- The Government is targeting a fiscal def- pillars: re-industrialization, development tor, and promote digitalization agenda. icit of around 3.0 percent of GDP in 2016, of innovative firms, capital for develop- Also, Poland needs to improve the effi- the Maastricht criterion and the Exces- ment, foreign expansion, and social and ciency of public administration and im- sive Deficit Procedure threshold. Despite regional development. prove the quality of public services. TABLE 2 Poland / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 1.3 3.3 3.6 3.7 3.5 3.5 Private Consumption 0.2 2.5 3.1 3.3 3.3 3.2 Government Consumption 2.2 4.9 3.6 2.8 3.7 2.7 Gross Fixed Capital Investment -1.1 9.8 5.9 4.0 4.7 5.3 Exports, Goods and Services 6.1 6.4 6.6 5.6 4.6 4.1 Imports, Goods and Services 1.7 10.0 5.9 4.9 5.0 4.2 Real GDP growth, at constant factor prices 1.3 3.3 3.5 3.8 3.7 3.6 Agriculture 9.1 1.1 -4.5 1.8 0.4 0.4 Industry 1.3 4.9 5.4 4.2 5.1 4.7 Services 1.1 2.8 3.1 3.7 3.2 3.3 Inflation (Consumer Price Index) 1.2 0.2 -0.9 0.5 1.0 1.5 Current Account Balance (% of GDP) -1.3 -2.0 -0.5 -0.9 -1.4 -1.9 Financial and Capital Account (% of GDP) 3.6 3.3 3.1 3.6 4.1 4.6 Net Foreign Direct Investment (% of GDP) 0.8 2.0 1.9 1.8 2.0 1.9 Fiscal Balance (% of GDP) -4.0 -3.3 -3.0 -3.0 -3.3 -3.2 Debt (% of GDP) 55.9 50.4 51.1 51.6 51.7 51.7 Primary Balance (% of GDP) -1.5 -1.4 -1.0 -1.0 -1.2 -1.2 Poverty rate ($2.5/day PPP terms) a,b,c 0.8 0.8 0.7 0.5 0.4 0.4 Poverty rate ($5/day PPP terms) a,b,c 5.0 4.7 4.4 2.8 2.7 2.5 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2004-EU-SILC and 201 2-EU-SILC. (b) P ro jectio n using po int-to -po int elasticity (2004-2012) with pass-thro ugh = 1based o n GDP per capita co nstant P P P . (c) 201 6 pro jectio n reflects expected impact o f the Family 500+ pro gram. P ro jectio ns are fro m 2013 to 2018. MPO 69 Apr 16 Country Pages ●  103 percent in 2014, helping Romania to ROMANIA Recent developments reach the medium term objective for the structural deficit for a second year in a row. The reduction in the deficit reflects Economic growth accelerated to 3.7 percent good revenue performance and expendi- in 2015 from 2.8 percent in 2014, driven by ture containment. Spurred by economic Table 1 2015 the domestic demand. On the expenditure growth, revenue collection increased Population, million 19.8 side, growth was led by private consump- from profit taxes (13 percent up nominal- GDP, c urrent US$ billion 186.2 tion (up 6.2 percent yoy) and by investment ly), income taxes (12.4 percent), and VAT GDP per c apita, c urrent US$ 9383 (up 7.5 percent yoy). Private consumption (12.3 percent). Investments from the Eu- Poverty rate ($2.5/day 2005PPP terms) a 11.1 was aided by the VAT rate cut for food in ropean funds advanced from 1.6 percent a June 2015, which boosted disposable in- of GDP in 2014 to 2.4 percent in 2015. The Poverty rate ($5/day 2005PPP terms) 32.6 comes and real wages. Investment dis- wage bill was flat relative to 2014, at 7.4 Gini Coeffic ient a 34.9 played a rebound led by advances in the percent of GDP, while interest payments b Sc hool enrollment, primary (% gross) 94.2 absorption of EU funds in the second half declined driven by the favorable financ- Life Expec tanc y at birth, years b 74.5 of 2015, and by improvements in the hous- ing conditions. Sources: World Bank WDI and M acro Poverty Outlook. ing market. On the production side, the Aided by the reduction in social contribu- Notes: drivers were retail trade (up 6.4 percent tions by 5 ppts in October 2014, real wages (a) M ost recent value (2012) (b) M ost recent WDI value (2013) yoy) and construction (up 8.8 percent yoy). increased by 11.5 percent yoy in October The ITC sector recorded a significant ex- 2015. Economic growth positively impacted pansion (up 11.8 percent yoy) and has be- employment, but improvements in labor come one of the most dynamic in the EU. force participation and job creation have The reduction in the standard VAT rate to been modest, signaling continued rigidities Economic growth accelerated in 2015, 20 percent from 24 percent, implemented in the labor market. The employment rate in January 2016, brought inflation deeper increased to 63.2 percent in Q3 of 2015, up driven by private consumption and invest- into negative territory, at -2.7 percent yoy from 62.6 percent in Q3 of 2014. The unem- ment. Fiscal consolidation continued, but a at end-February. Price declines have ployment rate was 6.8 percent in October tax reduction package adopted recently helped the NBR maintain accommodative 2015, similar to October 2014. will reverse this trend, putting pressure on monetary policy. The policy rate was kept Moderate poverty is projected to have de- at 1.75 percent in January, in the context of clined from a peak of 35.8 percent in 2011 to the budget deficit in 2016 and 2017. Eco- the large fiscal easing, closing of the out- 27.4 percent in 2015 using the $5.00/day nomic growth, fiscal relaxation and in- put gap and rising unit labor costs. De- 2005 PPP poverty line, reflecting increases creased support for vulnerable groups have spite the favorable liquidity conditions, in private consumption, higher employ- continued to reduce poverty. Reforms of credit growth continued to be subdued, ment, improved real wages, and increased SOEs and public spending should boost especially to corporations. Credit to corpo- support to vulnerable categories. Cuts to the rations fell 3.1 percent yoy in October 2015, VAT rate for food have increased house- Romania’s growth potential. Managing while credit to households registered an hold purchasing power and improved wel- fiscal risks in 2016 and 2017 requires care- expansion of 1.7 percent yoy. fare outcomes, as food makes up a larger ful attention by the authorities. The general government deficit declined portion of the budgets of the poorest mem- to 1.5 percent of GDP in 2015, from 1.9 bers of society. However, employment FIGURE 1 Romania / Contributions to annual GDP growth FIGURE 2 Romania / Actual and estimated poverty rates and GDP per capita Poverty Rate GDP per 8 (%) capita 50 25000.0 6 45 40 20000.0 4 35 2 30 15000.0 25 0 20 10000.0 15 -2 10 5000.0 -4 5 2010 2011 2012 2013 2014 2015 2016f 0 0.0 Net exports Private Consumption 2006 2008 2010 2012 2014 2016 2018 Gross fixed capital formation Public Consumption GDP $2.5/day PPP $5/day PPP GDP per capita Sources: World Bank and Romanian National Statistical Institute. Sources: World Bank. MPO 70 Apr 16 104  ●   World Bank ECA Economic Update April 2016 growth has been concentrated in high- stay in negative territory until June 2016, poverty rate is projected to decline to 25.6 skilled areas, while integration of young when the effect of the VAT cut for food percent in 2016 and to 24 percent in 2017. people and other excluded groups remains fades out, and it is likely it will gradually a challenge. increase towards 1.4 percent at end -2016, in line with NBR projections. Following the tax cuts and public sector Risks and challenges Outlook wage increases, the budget deficit will widen significantly in 2016 and 2017. In Risks to this outlook are important. The line with the 2016 budget and the Medi- short term fiscal risks, in particular, need Growth is expected to remain above po- um-Term Fiscal Framework, the consoli- to be carefully managed in the context of tential in 2016 and 2017, supported by dated budget deficit is projected to widen the uncertain external environment and of the expansionary fiscal policy and im- towards 3 percent of GDP in both 2016 the approaching general elections, sched- provements in the labor market. The fis- and 2017. In the absence of tax policy uled for the autumn of 2016. The revision cal relaxation measures implemented in changes, which seem unlikely in an elec- of the unitary public wage legislation, 2016, coupled with the wage increases in tion year, the government will need to currently underway, may increase spend- the public sector, will further boost pri- rely on the containment of current spend- ing pressures and amplify the risk of reen- vate consumption. Low inflation and ing, cuts in capital spending and im- tering into the EDP. Over the medium accommodative monetary conditions will provements in tax efficiency to avoid re - term, the focus of fiscal policy should be help improve credit and may positively entering the Excessive Deficit Procedure rebalanced from boosting consumption to impact private investment. Additional (EDP) and stay within the deficit 3 per- supporting long term sustainable growth. fiscal relaxation measures have been cent boundary of the EU Growth and A return to the stop-and-go approach to adopted by the government to be imple- Stability Pact. the unfinished structural reforms agenda, mented in 2017, including a further VAT Continued strong private consumption characteristic of the past, entails risks for cut to 19 percent, the elimination of the aided by a lower VAT and growth in em- the sustainability of the economic recov- special construction tax and a reduction ployment and real wages, should boost real ery. Structural reforms should focus on of the excise rate for fuels. We project a incomes and lead to further declines in pov- energy, SOEs, and on enhancing the quali- further acceleration of growth to 4 per- erty incidence. The planned introduction ty of public spending. Renewed efforts are cent in 2016. Acceleration of consump- of a minimum social inclusion income needed to improve labor participation and tion is also expected to widen external program is expected to improve targeting generate broad-based employment, as imbalances, but the current account defi- and increase the level of benefits for the unemployment remains high among the cit will remain manageable. Inflation will most vulnerable. The $5.00/day 2005 PPP youth and low-skilled. TABLE 2 Romania / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 3.4 2.8 3.7 4.0 3.7 3.4 Private Consumption -0.2 4.1 6.2 6.0 5.3 5.0 Government Consumption 14.0 13.6 1.5 3.5 3.6 3.5 Gross Fixed Capital Investment -9.2 -3.3 7.5 8.5 8.0 7.0 Exports, Goods and Services 14.4 8.2 4.7 5.9 5.4 5.6 Imports, Goods and Services 4.0 7.7 8.4 7.7 7.4 7.3 Real GDP growth, at constant factor prices 3.4 2.8 3.7 4.0 3.7 3.4 Agriculture 26.6 1.5 -9.4 5.3 3.3 3.3 Industry 8.0 3.6 2.0 2.9 3.3 3.3 Services -3.1 2.4 7.4 4.6 4.1 3.4 Inflation (Consumer Price Index) 4.0 1.1 -0.9 -0.3 2.4 2.7 Current Account Balance (% of GDP) -0.8 -0.5 -1.1 -2.3 -3.5 -4.1 Financial and Capital Account (% of GDP) 1.3 0.8 0.0 0.3 0.5 0.9 Net Foreign Direct Investment (% of GDP) 2.2 1.6 1.6 1.6 1.6 1.7 Fiscal Balance (% of GDP) -2.5 -1.9 -1.5 -2.8 -2.8 -2.7 Debt (% of GDP) 38.8 40.6 40.1 40.0 40.2 40.7 Primary Balance (% of GDP) -0.8 -0.3 0.0 -1.2 -1.2 -1.0 Poverty rate ($2.5/day PPP terms) a,b,c 10.3 9.6 8.8 8.1 7.4 6.8 Poverty rate ($5/day PPP terms) a,b,c 30.7 29.2 27.4 25.6 24.1 22.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2006-EU-SILC and 201 2-EU-SILC. (b) P ro jectio n using annualized elasticity (2006-2012) with pass-thro ugh = 0.7 based o n GDP per capita co nstant P P P . (c) P ro jectio ns are fro m 2013 to 2018. MPO 71 Apr 16 Country Pages ●  105 realignment and supported the economic RUSSIAN Recent developments transition. In 2015, the ruble’s average exchange rate depreciated 37.4 percent against the US dollar, while oil prices FEDERATION Facing a difficult economic adjustment, Russia’s economy went through a deep dropped 47 percent. Meanwhile, a 16.5 percent depreciation of the real effective recession in 2015, hitting its low point in exchange rate drove import volumes the second quarter of 2015. Expectations down 25.6 percent, nearly doubling the Table 1 2015 that Russia’s economy would rebound in current-account surplus to 5 percent of Population, million 143.3 the third quarter of 2015 did not material- GDP. Relative prices now favor Russian GDP, c urrent US$ billion 1324.8 ize. By the end of the year, Russia’s econo- firms, and export performance improved GDP per c apita, c urrent US$ 9242 my had contracted for six consecutive in some non-energy commodity sectors, a 0.8 quarters, with year-over-year negative such as coal, metals, and chemicals. Poverty rate ($2.5/day 2005PPP terms) a growth only moderating slightly to -4.1 Helped by the free float, the fiscal impact Poverty rate ($5/day 2005PPP terms) 7.3 percent in the third quarter and -3.7 per- of the adjustment was less severe than for Gini Coeffic ient a 41.6 cent in quarter four. other oil-exporter countries, yet Russia’s b Sc hool enrollment, primary (% gross) 100.6 An unanticipated second oil price shock in government needed to launch a fiscal- Life Expec tanc y at birth, years b 70.4 August renewed pressure on the ruble consolidation plan. and kept inflation in double digits at 15.6 Federal expenditure decreased in real Sources: World Bank WDI and M acro Poverty Outlook. Notes: percent. Rising inflation eroded real wag- terms but not enough to compensate for (a) M ost recent value (2012) es, pensions, and other transfers, contrib- declining oil revenues, resulting in a defi- (b) M ost recent WDI value (2013) uting to an estimated 7.9 percent decline cit of 2.4 percent. This was financed by the in consumption, the first contraction since Reserve Fund, which halved by the end of the global financial crisis of 2008. The au- 2015 to US$46.0 billion. A RUB2.4 billion In 2015, Russia’s economy saw the conse- thorities’ efforts to contain inflationary anti-crisis plan helped to cushion some of pressures presented an obstacle to mone- the consolidation’s impacts—e.g., through quences of the previous year’s oil price shock tary easing, and the central bank has kept the full indexation of pensions—and sup- and sanctions causing real GDP to contract its key policy rates at 11 percent since Au- ported financial-sector stability through 3.7 percent. A second oil price shock in Au- gust 2015. Meanwhile, international sanc- bank recapitalization. gust delayed an anticipated recovery. The tions have been extended, limiting access The moderate poverty rate (US$5 in 2005 to global financial markets, restricting PPP) rose from 7.0 percent in 2014 to 7.7 economy adjusted through a sharp drop in capital inflows, and damaging investor percent in 2015. Adverse trends in infla- gross domestic income, which sapped con- confidence. High capital costs and plum- tion and income both played roles in the sumer demand and discouraged investment. meting consumer demand provided firms higher poverty rate. Food price inflation External balances adjusted smoothly, helped with little incentive to invest in expanded averaged 19.1 percent in 2015 and dispro- by the central bank’s adherence to the free production; as a result, gross capital for- portionately reduced the purchasing pow- mation dropped by 18.3 percent in 2015, er of poorer households, where food float. However, a tight fiscal stance, accom- contracting for a third consecutive year. makes up over 40 percent of total con- panied by double-digit inflation, negatively The central bank’s adherence to a flexible sumption. Nominal wage growth could impacted poverty trends. exchange rate regime fostered currency not compensate for the high inflation, and FIGURE 1 Russian Federation /GDP growth structure FIGURE 2 Russian Federation / Actual and estimated pov- (percentage points/percent) erty rates and GDP per capita (PPP) 15 Poverty Rate (%) GDP per capita (USD PPP) 50 25,000 10 45 5 40 20,000 35 0 30 15,000 25 -5 20 10,000 -10 15 10 5,000 -15 5 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 0 Stat error Import 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Export Change in inventories $2.5/day PPP $5/day PPP Gross Fixed Capital Formation Consumption GDP per capita PPP Sources: Russian Statistical Authorities and World Bank staff calculations. Source: World Bank (see notes to table 2). MPO 72 Apr 16 106  ●   World Bank ECA Economic Update April 2016 real wages fell 9.5 percent in 2015. The their 2015 average of around US$50 per At the same time, the policy space for Rus- bright spot is that unemployment in- barrel. Commodity prices will continue to sia’s second phase of adjustment is shrink- creased only slightly to 5.6 percent, up dominate Russia’s medium-term outlook. ing in light of depleting fiscal buffers. from a record low of 5.3 percent in 2014. GDP growth is projected to return to a Maintaining fiscal discipline will require However, the limited indexation of public positive 1.1 percent in 2017 due to im- bold choices during the 2017 budget- wages, pensions, and transfers impacted proving investment dynamics, led by ris- planning process, with authorities striving poor households that rely on the public ing oil prices and declining credit cost. to determine the structure and policy pri- sector for a significant part of their in- Russia’s poverty rate is expected to rise orities of the medium-term fiscal frame- comes (close to 60 percent of the income of further in 2016 as the economy continues work. A massive bank recapitalization the poorest 20 percent of the population to contract and unemployment rises. temporarily stabilized the financial sector, comes from public-sector wages, pen- Meanwhile, fiscal consolidation will limit but managing systemic vulnerabilities will sions, and other transfers). Real income the government’s latitude for countercy- require constant vigilance and a readiness growth among the bottom 40 percent of clical policies and antipoverty spending. to implement further measures. Russia’s the population did not continue to con- Poverty, as measured by the international longer-term growth will depend on the verge with average income growth—so moderate poverty line, is expected to rise strength of its structural reforms. progress on shared prosperity slowed. from 7.7 percent in 2015 to 8.0 percent in Poor households have come to rely in- 2016. The economic recovery envisaged in creasingly on fiscal transfers, pensions, 2017 and stronger targeting of social bene- and public-sector wages. There is scope to Outlook fits are expected to support a decline in the poverty rate to 7.7 percent in 2017. extend support to the most vulnerable through improved targeting of social- protection programs—i.e., allocating pub- The conditions that pushed Russia’s econ- lic funds with fewer leakages to the non- omy into recession are likely to linger, and the World Bank’s current baseline scenar- Risks and challenges poor and a higher poverty-reduction im- pact. Over the medium-term, the chal- io anticipates another tough year, with a lenge will be restoring the labor market as decline in real GDP of 1.9 percent in 2016. The focus of Russia’s economic adjust- the driver of poverty reduction and the Oil prices are projected to average US$37 ment is now shifting to challenges in fiscal income growth among the bottom 40 per- per barrel in 2016, then rebound in 2017 to policy and financial-sector restructuring. cent of the population. TABLE 2 Russian Federation / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 1.3 0.7 -3.7 -1.9 1.1 1.8 Private Consumption 3.7 1.7 -10.1 -3.0 0.4 2.0 Government Consumption 1.4 0.4 -1.8 -1.0 -0.6 0.0 Gross Fixed Capital Investment 0.9 -0.6 -7.6 -7.5 3.7 6.6 Exports, Goods and Services 4.8 0.3 3.1 2.5 2.0 2.0 Imports, Goods and Services 2.3 -5.9 -25.6 -3.5 3.5 10.0 Real GDP growth, at constant factor prices 1.3 0.8 -3.6 -1.8 1.1 1.8 Agriculture 4.7 2.2 3.5 4.0 2.0 2.0 Industry 0.6 0.7 -3.7 -0.5 1.5 2.5 Services 1.2 0.8 -3.9 -2.2 1.0 1.7 Inflation (Consumer Price Index) 6.8 7.8 15.6 7.6 4.8 4.0 Current Account Balance (% of GDP) 1.6 2.9 5.2 3.5 2.4 1.0 Financial and Capital Account (% of GDP) -1.1 -3.2 -4.9 -3.5 -2.4 -1.0 Net Foreign Direct Investment (% of GDP) -0.8 -1.7 -2.0 -1.0 -0.6 -0.5 Fiscal Balance (% of GDP) -1.2 -1.1 -3.5 -4.6 -2.3 -2.2 Debt (% of GDP) 12.8 14.3 14.6 15.4 18.6 19.6 Primary Balance (% of GDP) -0.6 -0.4 -2.7 -3.8 -1.0 -0.9 Poverty rate ($2.5/day PPP terms) a,b,c 0.7 0.7 0.8 0.9 0.9 0.8 Poverty rate ($5/day PPP terms) a,b,c 7.1 7.0 7.7 8.0 7.7 7.3 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 2-HB S. (b) P ro jectio n using neutral distributio n (2012) with pass-thro ugh = 1 based o n GDP per capita co nstant P P P . (c) P ro jectio ns are fro m 2013 to 201 8. MPO 73 Apr 16 Country Pages ●  107 2015. While rising private sector employ- Recent developments ment has improved welfare, the decline in SERBIA agriculture output in 2015 is likely to have had adverse impacts on rural poverty. Growth in 2015 turned out to be stronger The Government’s ongoing fiscal consoli- than previously projected. After a strong dation program, as supported by a precau- Table 1 2015 rebound in Q3 to 2.3 percent y/y, initial tionary IMF program, aims to put public Population, million 7.1 estimates of real GDP growth in Q4 were debt-to-GDP on a downward path from a GDP, c urrent US$ billion 36.1 1.2 percent y/y. Growth for 2015 as a peak of 79 percent in 2016. Measures, in- GDP per c apita, c urrent US$ 5091 whole is estimated at 0.8 percent, well cluding freezes and cuts in public wages Poverty rate ($2.5/day 2005PPP terms) a 1.4 above a contraction of 0.5 percent original- and pensions, and increases in electricity a ly projected in early 2015. Private invest- tariffs, along with a substantial increase in Poverty rate ($5/day 2005PPP terms) 14.5 a ment was particularly supportive. Growth one-off non-tax revenues, resulted in a Gini Coeffic ient 29.1 could have been even stronger if not for a major decrease of the fiscal deficit – from b Sc hool enrollment, primary (% gross) 93.0 drought. Agricultural output (accounting 6.7 percent of GDP in 2014 to 3.7 percent in Life Expec tanc y at birth, years b 74.8 for 8 percent of GDP) declined by 7.6 per- 2015. These measures may have limited Sources: World Bank WDI and M acro Poverty Outlook. cent y/y in real terms in 2015. immediate poverty impact since public Notes: As growth returned, unemployment fell sector employees are less likely than others (a) M ost recent value (2013) (b) M ost recent WDI value (2013) steadily from 19.4 percent in 2014 to 17.9 to be in the bottom income quintiles. How- percent in 2015. Both the activity rate and ever, further retrenchments may have neg- employment rate, ending in Q4 2015 at ative poverty impacts. The 2014 nominal 51.6 percent and 42.4 percent respectively, cuts in pensions were progressive, but the Serbia’s economic performance in 2015 are returning to pre-crisis levels. Private, freezing of pension indexation was across was marked by a return to growth and a formal sector jobs increased in 2015 while the board. the government continued to impose a Inflation continues to undershoot its target decline in unemployment despite the ongo- hiring freeze and SOEs reduced employ- band, due to lower oil prices and weak ing implementation of the Government’s ment by around 15,000 people (0.6 percent domestic demand. Inflation remained in fiscal consolidation program. Progress on of total employment). Overall, the average the range of 2 percent throughout 2015, key fiscal and structural reforms was number of employed persons increased although picked up in January 2016 to 2.4 maintained, but many challenging reforms slightly in 2015. With public sector wages percent y/y, in part due to a significant rise reduced, aggregate real wages continued in food prices. Low inflation in 2015 remain. Poverty, which reached an esti- to decline in 2015, down 2 percent y/y. helped protect purchasing power, but the mated 14.5 percent (living under $5/day Poverty reduction has slowly resumed food price rise in early 2016 is likely to PPP) in 2014, is expected to decline to since poverty peaked in 2010. As a result disproportionately affect the poor. The 13.9 percent in 2016. High degrees of vul- of some improvements in economic and impact of the increase in electricity tariffs employment conditions, the poverty rate – on the poor was to some extent mitigated nerability remain due to still weak labor using the regional poverty line of $5/day by regulated discounts for energy vulnera- markets and, if not mitigated, the impacts in 2005 PPP – dropped from 15.1 percent ble customers. After substantial easing in of fiscal consolidation measures in 2010 to 14.5 percent in 2013. Poverty is 2015, the monetary policy rate was cut a estimated to remain at 14.4 percent in further 0.25 percentage points in January FIGURE 1 Serbia / Contributions to annual GDP growth FIGURE 2 Serbia / Actual and estimated poverty rates and GDP per capita (PPP) Percent Poverty Rate (%) GDP per capita (USD PPP) 6 30 16,000 4 14,000 25 12,000 2 20 10,000 0 15 8,000 6,000 10 -2 4,000 5 2,000 -4 2012 2013 2014 2015e 2016p 2017p 2018p 0 0 Private consumption Government consumption 2003 2005 2007 2009 2011 2013 2015 2017 Investment Net exports $2.5/day PPP $5/day PPP GDP, real growth GDP per capita PPP Sources: World Bank Staff Calculations based on Statistical Office Data. Sources: World Bank (see notes to Table 2). MPO 74 Apr 16 108  ●   World Bank ECA Economic Update April 2016 2016, in the face of weak domestic and of consumption, and improving external global inflation pressures. External sector performance has im- demand. Ongoing fiscal consolidation measures - targeting an additional struc- Risks and challenges proved, supported by the pick-up in tural reduction in the deficit of 2.3 per- growth in Europe in 2015. Merchandise cent over 2016-2018, following a 2.5 per- While recognizing the positive fiscal con- exports grew by 6.6 percent in 2015 (in cent reduction in 2015 - will limit near- solidation progress, there remains the euro terms) while imports increased by 4.1 term domestic demand, but will be bene- need for sustained implementation of the percent, as investment recovered. With ficial in the medium-term through sup- structural reforms. This is crucial in order service exports and remittances up by 12.2 porting investment. The main domestic to maintain macro stability and to create percent and 11.5 percent respectively, the risk to growth is delays in structural re- an environment conducive for higher current account deficit reached a record forms, for example, due to the impact of (private sector led) growth and poverty low level of 4.7 percent of GDP (down 20 the early elections which may also deter reduction over the medium term. percent in euro terms on 2014). Foreign foreign investors. With domestic demand The potential distributional impacts of direct investments in 2015 increased signif- only recovering gradually and low im- comprehensive structural reforms, while icantly (by 46 percent). The dinar has fall- port prices, inflation is set to return to the supportive of future overall employment en slightly against the euro since the end target band only in mid -2016. and income growth, are likely to pose of 2015. The banking sector remains stable With economic growth and improve- challenges to poverty reduction in the and loans to private sector increased by 3 ments in the labor market though with short term, requiring mitigating measures. percent by year end, while loans to house- remaining structural challenges, poverty Moreover, despite recent improvements, holds increased 4.7 percent. is expected to decline gradually. Poverty labor force participation and employment measured at the $5/day poverty line is ratios are still low while unemployment is estimated to decline slowly to 14 percent high, especially for youth. Social protec- Outlook in 2016 and 13.5 percent in 2017. Possible tion and job opportunities to mitigate ad- future rises in energy prices as part of verse impacts and facilitate access to em- financial consolidation plans are ex- ployment need to be an important part of We project growth in Serbia to rise from pected to increase energy stress, particu- the policy agenda. 0.8 percent in 2015 to 1.8 percent in 2016 larly on poor households, who spend and to 3.5 percent by 2018, underpinned disproportionately more on energy as by rising investment, a gradual recovery part of total budget. TABLE 2 Serbia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 2.6 -1.7 0.8 1.8 2.3 3.5 Private Consumption -0.6 -1.3 -0.6 0.1 1.6 2.2 Government Consumption -1.1 0.2 -2.6 1.6 0.6 3.4 Gross Fixed Capital Investment -12.0 -3.8 8.3 6.7 6.4 6.0 Exports, Goods and Services 21.3 5.7 8.2 7.7 7.6 7.7 Imports, Goods and Services 5.0 5.6 6.1 6.0 5.7 5.7 Real GDP growth, at constant factor prices 3.3 -1.8 0.5 1.9 2.2 3.5 Agriculture 20.9 1.4 -8.1 8.1 2.7 3.6 Industry 4.2 -6.9 4.6 4.3 5.2 5.6 Services 0.4 0.2 0.0 -0.2 0.5 2.4 Inflation (Consumer Price Index) 7.8 2.1 1.9 1.7 3.1 3.5 Current Account Balance (% of GDP) -6.1 -6.0 -4.7 -4.6 -4.4 -4.3 Financial and Capital Account (% of GDP) 5.7 5.1 3.5 5.7 5.9 5.7 Net Foreign Direct Investment (% of GDP) 3.8 3.7 5.5 4.8 4.7 4.5 Fiscal Balance (% of GDP) -5.6 -6.6 -3.7 -3.6 -2.7 -1.8 Debt (% of GDP) 61.0 71.7 76.8 78.7 77.7 74.7 Primary Balance (% of GDP) -3.1 -3.6 -0.3 -0.1 1.0 2.1 Poverty rate ($2.5/day PPP terms) a,b,c 1.4 1.5 1.4 1.4 1.3 1.2 Poverty rate ($5/day PPP terms) a,b,c 14.5 14.7 14.4 14.0 13.5 12.9 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2006-HB S and 201 3-HB S. (b) P ro jectio n using po int-to -po int elasticity (2006-2013) with pass-thro ugh = 1based o n GDP per capita co nstant P P P . (c) A ctual data: 201 3. P ro jectio ns are fro m 201 4 to 2018. MPO 75 Apr 16 Country Pages ●  109 contributed to external debt reduction SLOVENIA Recent developments to 116 percent of GDP in 2015 (from 124.2 percent of GDP in 2014), while government at the same time increased After reaching 3 percent in 2014, economic its borrowings. activity continued to expand by unexpect- The banking sector consolidation contin- Table 1 2015 edly high 2.9 percent in 2015. Growth re- ued with two banks being liquidated in Population, million 2.1 mained robust driven by decelerating February 2016 and folded into the Bank contribution of exports of goods and in- Assets Management Company, the bad GDP, current US$ billion 42.8 vestments, but strengthened personal con- bank, although without negative fiscal GDP per capita, current US$ 20763 sumption. After declining for five consec- impact since banks have positive capital a Poverty rate ($5/day 2005PPP terms) 0.2 utive years, government consumption and will be able to settle their outstanding Gini Coefficient a 25.6 increased in 2015 as fiscal consolidation liabilities to the state. School enrollment, primary (% gross)b 98.9 efforts eased. Fiscal consolidation continued in 2015 Life Expectancy at birth, yearsb 80.1 A recovery of consumption reflects rising with fiscal deficit likely brought down consumer confidence, continued low ener- below 4 percent of GDP on the back of Sources: World Bank WDI and M acro Poverty Outlook. Notes: gy prices and improved labor market con- reduced expenditures but also rising reve- (a) M ost recent value (2012) ditions with growing employment (up by nues. Improved economic and labor mar- (b) M ost recent WDI value (2013) 0.9 percent), particularly in manufacturing ket situation, increase in some taxes and administrative and support services. (extension of the fourth personal income Survey-based unemployment rate declined tax bracket) and charges, as well as broad- to 9 percent, some 0.7 percentage points ening of the social contribution basis below the 2014 level. Major breakthrough, helped boosting revenues. Austerity Economic activity continued to be strong in however, was achieved with a decline of measures extended on the wage freeze, 2015 boosted by investments and private youth unemployment rate which at 17.1 subsidies, investments and capital trans- percent is now approaching the pre-crisis fers reduced overall expenditures. Never- consumption recovery. Improved labor levels. Apprenticeship programs as well as theless, public debt grew above 84 per- market conditions pushed the unemploy- Youth Guarantee Scheme financing helped cent of GDP by September 2015 from 80.8 ment rate down to 9 percent and is likely to with the school-to-work transition of percent in 2014 . decrease further as job creation is expected youth. Increase in net wages underpinned The Fiscal Rules Act was passed, but an by deflationary pressures which marked independent Fiscal Council, a new inde- to pick up in the projection period. The fis- the whole of 2015 resulted in higher house- pendent body tasked with monitoring cal consolidation efforts have likely brought hold disposable income which likely led to fiscal policy, has yet to be appointed. The deficit down below 4 percent of GDP in further decline of poverty. government has nominated three experts 2015, while public debt remained elevated The current account surplus continued to to the fiscal council, which will need the at above 83 percent of GDP in 2015. Ongo- increase for a fifth year in a row reaching support of two thirds of MPs to be ap- historically high levels, 7.3 percent of pointed for a five-year term on the coun- ing deleveraging contributed to reducing GDP in 2015, primarily owing to faster cil. The council will assess the compliance external vulnerabilities and improving net growth of export of goods and services. of fiscal policy with the fiscal rule and EU international investment position. Deleveraging trend in the corporate sector regulations, monitor the implementation FIGURE 1 Slovenia / Contributions to annual GDP growth FIGURE 2 Slovenia / Unemployment rate (%) Percent Percent 10 12 5 10 0 8 -5 6 -10 4 -15 2 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016f 0 Final consumption Gross fixed capital formation 2010 2011 2012 2013 2014 2015 2016f 2017f 2018f Change in inventories Net exports Residual item GDP growth Unemployment rate Sources: SORS, World Bank. Sources: SORS, World Bank. MPO 76 Apr 16 110  ●   World Bank ECA Economic Update April 2016 of the state budget as well local, pension international investment position im- and Spain. Although at more unfavorable and health budgets. It will also assess provement is expected to continue and conditions, this issue together with the whether circumstances have arisen that reduce risks to its external position. sovereign's cash reserve ensured the sov- warrant a deviation from the objective of Fiscal consolidation is likely to continue in ereign is prefunded by mid-2017. having the budget balanced over the me- the projection period with fiscal deficit dium term. declining to 1.9 percent of GDP by 2018 supported by economic recovery but also government measures which are expected Risks and challenges Outlook to remain in effect in the next few years. The Commission could in 2016 stop the Risks to the outlook are set on the down- excessive deficit procedure, which it side. Slovenia’s economic growth could Slovenia's economy is expected to moder- launched in December 2009, as Slovenia is be hampered by a slowdown in its main ate to 1.8 percent in 2016 mainly due to on track to bringing the deficit below the 3 trading partners and worsening of the lower public investment as previous pro- percent of GDP ceiling. However, the fo- already volatile financial markets. On the gramming period of the EU funding came cus on fiscal policy will then be on reach- domestic side, the slow resolution of the to the end. However, the growth is ex- ing the medium-term budgetary objective, banking sector NPLs, the resolution of the pected to accelerate again from 2017. The which in Slovenia's case means a balanced assets held in the Bank Asset Manage- main drivers of economic recovery will be budget or a structural effort of 0.6 percent ment Company, delayed fiscal consolida- private consumption reflecting further of GDP in 2016 for an appropriate adjust- tion process and structural reforms could growth in disposable income amid im- ment path towards the MTO. Public debt undermine projected growth. proving consumer confidence and labor is also expected to start declining after Despite recent improvements, labor mar- market conditions, and private invest- years of steep growth. ket continues to struggle with structural ment which is expected to accelerate To finance 2016 budget needs, the govern- challenges. Long-term unemployment gradually due to lower indebtedness but ment in February issued a 16-year bond decreased but still accounts for over half also improved access to finance. The con- worth EUR1.5bn at 147 basis points of the total unemployed, while employ- tribution of net exports is to decrease pro- spread over mid-swaps, implying yield of ment rates of low-skilled and older gressively, as domestic demand fuels 2.338 percent. Unstable conditions on the workers remained low. Although de- imports; by mid-2017 economic growth is capital markets at the start of 2016 caused creased to 11.5 percent of total loans, the expected to be almost fully driven by do- the actual spread to nearly double com- level of NPLs remained high which to- mestic demand. pared to 20-year Eurobond of 1 billion gether with low credit demand, delever- The current account surplus is projected issued in March last year, but also the aging pressures and credit risk, continue to remain high, as long as deleveraging final pricing is about 0.35-0.40 percentage to exert pressure on the profitability of in the corporate sector continues. Net points above EMU peripherals like Italy the banking sector. TABLE 2 Slovenia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices -1.1 3.0 2.9 1.8 2.2 2.4 Private Consumption -4.1 0.7 1.7 1.2 1.5 1.8 Government Consumption -1.5 -0.1 0.7 0.2 0.6 0.9 Gross Fixed Capital Investment 1.7 3.2 0.5 0.4 3.0 3.4 Exports, Goods and Services 3.1 5.8 5.2 4.9 4.4 4.3 Imports, Goods and Services 1.7 4.0 4.4 4.0 4.0 3.9 Real GDP growth, at constant factor prices -0.7 3.8 2.9 1.8 2.2 2.4 Agriculture -4.3 10.0 2.4 2.5 1.5 1.6 Industry -1.7 5.5 3.1 2.5 2.4 2.4 Services -0.2 2.9 2.8 1.5 2.1 2.4 Inflation (Consumer Price Index) 1.8 0.2 -0.5 0.8 1.5 1.8 Current Account Balance (% of GDP) 5.6 7.0 7.3 7.8 7.5 7.2 Financial and Capital Account (% of GDP) -3.4 -6.7 -5.0 -5.5 -5.5 -5.1 Net Foreign Direct Investment (% of GDP) 0.1 1.6 2.3 2.5 2.6 2.8 Fiscal Balance (% of GDP) -15.0 -5.0 -2.9 -2.7 -2.1 -1.9 Debt (% of GDP) 70.8 80.8 83.6 80.3 79.5 78.0 Primary Balance (% of GDP) -12.4 -1.8 0.2 0.4 0.9 1.0 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 77 Apr 16 Country Pages ●  111 mitigating pressures on the economy and TAJIKISTAN Recent developments the external accounts. A sharp contrac- tion in imports improved the trade bal- ance, but plummeting remittances wid- Tajikistan’s GDP growth rate slowed ened the current -account deficit from 3.6 from 6.7 percent in 2014 to an estimated percent of GDP in 2014 to an estimated 6 Table 1 2015 4.2 percent in 2015 as external conditions percent in 2015. Population, million 8.5 deteriorated. Remittances from Russia Russia’s ongoing recession, the deprecia- GDP, c urrent US$ billion 7.9 declined, demand for Tajikistan’s ex- tion of the ruble and the tightening of GDP per c apita, c urrent US$ 930 ports remained weak, and prices for the immigration regulations caused remit- Poverty rate (LCU 165.628/month)a 31.3 country’s key export commodities— tances to decline by 33 percent in US aluminum and cotton—continued to fall. dollar terms in 2015. Although the de- Gini Coeffic ient a 28.0 Externally financed public investment cline was less dramatic in somoni terms Sc hool enrollment, primary (% gross)b 99.6 doubled, stimulating the growth of con- (16 percent), lower real remittances and Life Expec tanc y at birth, yearsb 67.3 struction and construction -related indus- limited job creation in the domestic for- Sources: World Bank WDI and M acro Poverty Outlook. try, which offset the poor performance mal sector slowed the pace of poverty Notes: (a) M ost recent value (2015) of services. reduction. The national poverty rate fell (b) M ost recent WDI value (2013) The sharp increase in foreign -financed from 37.4 percent in 2012 to 31.3 percent investment widened the fiscal deficit to in Q3 2015, but it remained essentially 2.2 percent of GDP in 2015 from a near unchanged between the first and third balance in 2014. Domestic tax and nontax quarters of 2015. Between May and No- revenues rose as the authorities in- vember, seasonally unadjusted average Tajikistan’s economy grew by 4.2 percent creased pressure on businesses to meet real per capita income climbed among revenue targets, which partially compen- households in the top 60 percent of the in 2015, driven by a large increase in gov- sated for a decline in revenues from for- distribution and remained largely un- ernment investment, which partially off- eign economic activities. Although the changed among those in the bottom 40 set the adverse impact of negative exter- primary fiscal balance was close to zero percent. During the summer and fall, the nal conditions. The fiscal and external in 2015, rising debt -service obligations decline in the real value of remittances and contingent liabilities generated by was partially offset by seasonal increases accounts deteriorated, affected by the state-owned enterprises (SOEs) are nar- in remittance volumes, agricultural in- sharp fall in remittances and foreign- rowing the fiscal space. As of end -2015, come and self-employment earnings. financed public investment. The economy the total debt stock of the 24 largest SOEs However, this trend reversed in the win- is expected to recover slowly over the me- was estimated at 44 percent of GDP, and ter months, when declines in remittanc- dium term as the external environment about 75 percent of bank loans to SOEs es, wages, self-employment earnings and are classified as nonperforming loans agricultural income per capita were ob- improves. Falling remittances and slug- (NPLs). The overall share of NPLs in the served across all regions and income gish employment growth will slow the banking system increased to 30 percent levels as the agricultural season ended pace of poverty reduction, but continued by the end of the year. and migrant workers returned. progress is expected through 2018. The somoni depreciated by over 24 per- cent against the US dollar during 2015, FIGURE 1 Tajikistan / GDP growth decomposition FIGURE 2 Tajikistan / Actual and projected national poverty rates and GDP growth percent poverrt rate GDP growth 8.0 (%) 40 8.0 35 7.0 6.0 30 6.0 25 5.0 4.0 20 4.0 15 3.0 2.0 10 2.0 5 1.0 0.0 0 0.0 2013 2014 2015e 2016p 2017p 2018p 2013 2014 2015e 2016p 2017p 2018p Net Taxes Services Poverty rate (TJS 158.71/month) Industry Agriculture GDP growth (annual % change) GDP growth (annual % change) Sources: TajStat, World Bank staff estimates. Sources: World Bank (see Notes to Table 2). MPO 78 Apr 16 112  ●   World Bank ECA Economic Update April 2016 Poverty reduction is expected to continue. reduce exports and foreign direct invest- Outlook The national poverty rate is projected to drop to 30.4 percent in 2016 and 28.1 per- ment. Risks arising from SOEs and the financial sector could threaten both over- cent in 2018. Food prices climbed signifi- all economic growth and fiscal revenues. The GDP growth rate is projected to re- cantly in the first quarter of 2016, dispro- Despite the numerous reforms initiated by main at about 4 percent in 2016 as the con- portionately impacting poorer and rural the new central bank management, high tinued expansion of public investment households for whom food represents an NPL ratios, weak capital positions and counters the effects of an adverse external especially large share of total consump- liquidity constraints continue to weaken environment. A further decline in remit- tion. The planned expansion of the Target- the financial sector. tances, albeit at a slower pace, is expected ed Social Assistance Program to 40 dis- In a context of limited private sector to put downward pressure on private con- tricts in 2016 and then to the entire coun- growth, declining remittance inflows and sumption growth. Large construction pro- try is expected to mitigate the impact of weak external demand, the government’s jects, some related to the 25th anniversary the worsening external environment on main policy challenges will be to promote of Tajikistan’s independence, will continue extreme poor, while a proposed increase job creation, maintain fiscal sustainability to drive the rapid growth of the industry in pensions and benefits is expected to and protect pro-poor spending. Key prior- and construction sectors, while the depre- have a positive effect on poverty. ities include addressing financial sector ciation of the somoni will encourage im- vulnerabilities and improving the govern- port substitution. High rates of public in- ance of SOEs to minimize fiscal risks and vestment and planned increases in public sector wages and benefits will further wid- Risks and challenges enhance service delivery. Further progress on the structural reform agenda would en the fiscal deficit. Growth is expected to improve the business climate, helping accelerate over the medium term as the Risks to the outlook are tilted to the Tajikistan sustain economic growth, posi- external environment improves, large- downside. A weaker-than-expected recov- tive employment dynamics and steady scale investment continues and remittanc- ery in Russia and Kazakhstan could de- poverty reduction despite an adverse ex- es recover, but growth rates will remain press remittances, while a more severe ternal environment. below recent historical averages. slowdown in Turkey and China could TABLE 2 Tajikistan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 7.4 6.7 4.2 4.0 4.8 5.3 Private Consumption 4.1 4.1 -1.2 0.0 3.0 3.7 Government Consumption -20.7 0.9 3.1 2.5 2.3 2.3 Gross Fixed Capital Investment 35.4 2.6 12.9 9.0 8.1 9.3 Exports, Goods and Services 5.5 5.5 3.5 5.8 6.5 7.3 Imports, Goods and Services 5.9 5.9 1.5 4.5 5.0 6.5 Real GDP growth, at constant factor prices 7.4 5.2 4.2 3.9 4.8 5.2 Agriculture 10.0 4.5 4.5 4.7 4.9 5.0 Industry 8.8 6.0 6.3 6.5 6.8 7.0 Services 5.3 5.3 3.1 2.1 3.8 4.5 Inflation (Consumer Price Index) 5.0 6.1 5.8 10.5 8.5 8.0 Current Account Balance (% of GDP) -2.4 -3.6 -6.0 -5.9 -5.0 -3.4 Financial and Capital Account (% of GDP) 0.1 3.2 5.5 5.6 5.0 2.1 Net Foreign Direct Investment (% of GDP) 1.0 2.9 2.9 4.1 3.6 4.0 Fiscal Balance (% of GDP) -1.1 -0.1 -2.2 -3.3 -3.0 -2.4 Debt (% of GDP) 38.0 36.5 39.9 47.3 48.5 52.4 Primary Balance (% of GDP) 0.1 0.4 -0.1 -1.2 -0.4 -0.7 Poverty rate (LCU 165.628/month Somoni) a,b,c 34.3 32.0 31.3 30.4 29.3 28.1 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n 201 5 HB S. (b) P ro jectio n using neutral distributio n (201 5) with pass-thro ugh = (0.7) based o n GDP per capita co nstant P P P . A ctual data: 2013, 2014, 2015. P ro jectio ns are fro m 2016 to 2018. (c) A ctual data: 201 3, 2014, 2015. P ro jectio ns are fro m 2016 to 2018. MPO 79 Apr 16 Country Pages ●  113 creation in non-agricultural sectors TURKEY Recent developments slowed and the non-agricultural unem- ployment rate stabilized around 12.5 per- cent in Q4 of 2015. The Justice and Development Party (AK The gold-adjusted current account deficit Party) regained the majority in the No- narrowed by 0.3 percentage points to 5.0 Table 1 2015 vember 1 parliamentary elections, ending percent of GDP in 2015, thanks to the Population, million 76.7 political uncertainty. However, attempts large fall in energy prices. However, the GDP, c urrent US$ billion 716.9 to bolster the AK Party’s support in par- current account improvement was much GDP per c apita, c urrent US$ 9345 liament and push for constitutional chang- smaller than expected, indicating that the Poverty rate ($2.5/day 2005PPP terms) a 3.4 es could prove a major distraction in the core current account deficit actually wid- a near future. ened. This deterioration in fundamentals Poverty rate ($5/day 2005PPP terms) 18.7 a Despite election uncertainty, growth is highlights that external adjustment is Gini Coeffic ient 40.2 estimated to have increased to 4.2 percent driven by cyclical factors instead of struc- b Sc hool enrollment, primary (% gross) 100.0 from 2.9 percent in 2014, thanks to strong tural reforms. On the financing side, in- Life Expec tanc y at birth, years b 74.9 domestic demand. Government spending flows to Turkey slowed sharply due to Sources: World Bank WDI and M acro Poverty Outlook. continued to support growth, while pri- domestic political uncertainty and a dete- Notes: vate investment remained depressed amid rioration in global risk appetite. Amid (a) M ost recent value (2013) (b) M ost recent WDI value (2013) a weakening business climate. Exports large portfolio outflows Central Bank re- slowed sharply due to slower demand serve assets dropped by $11.8 billion in from the EU, the economic crisis in Russia, 2015. The population at the lower end of and geopolitical developments. However, the income distribution has benefitted Growth is estimated to have increased to real exchange rate depreciation led to a from both improved access to jobs as well decline in imports and a positive contribu- as access to better jobs with higher income 4.2 percent in 2015, much higher than tion of net exports to growth in 2015. and less informality. This has resulted in a expected. Despite depressed consumer Nominal wage growth was comfortably continued decreasing trend in poverty. confidence and election uncertainty, pri- above the inflation rate, which buoyed For 2013, the latest year of available data, vate consumption became the main driver disposable incomes and encouraged con- extreme poverty (based on US$2.5 per sumer spending. Lower global oil prices day) affected 3.4 percent of the popula- of growth, thanks to strong real wage reduced outlays for fuel and this income tion, while moderate poverty (based on growth, a large decline in oil prices, and effect fueled consumption. Moreover, US$5 per day) decreased to 18.7 percent. the wealth effect from currency deprecia- many households hold foreign currency tion. Turkey`s economy continues to face deposits, and thus the large depreciation headwinds on several fronts, which justi- of the lira created a wealth effect, which also supported consumption. However, Outlook fies a cautious medium-term, macro- pass-through of currency depreciation poverty outlook. stoked inflation, to 9.6 percent by January We expect private consumption to con- 2016, significantly above the Central tinue to drive growth in 2016, thanks to Bank`s target band of 3-7 percent. Despite the 30 percent rise in the minimum wage the higher overall growth, employment introduced in January and a small but FIGURE 1 Turkey / Contributions to annual GDP growth FIGURE 2 Turkey / Actual and estimated poverty rates and GDP per capita (PPP) Contributions to Growth Poverty Rate (%) GDP per capita (USD PPP) 15% 60 25,000 10% 50 20,000 5% 40 15,000 0% 30 10,000 -5% 20 5,000 10 -10% 0 0 -15% 2002 2004 2006 2008 2010 2012 2014 2016 2018 1999 2001 2003 2005 2007 2009 2011 2013 2015 $2.5/day PPP $5/day PPP C I G Stocks NX GDP GDP per capita PPP Sources: Turk Stat. Sources: World Bank (See notes to Table 2). MPO 80 Apr 16 114  ●   World Bank ECA Economic Update April 2016 positive contribution from public spend- Poverty is expected to continue its down- reforms. The new government is well ing. Continued demand pressures are ward trend, but the rate of poverty reduc- positioned to proceed with the implemen- likely to make disinflation a slow process. tion may be lower in the coming years. It tation of its structural reform program to Lira depreciation has strained balance is anticipated that employment and wage bring back investment and productivity sheets and raised the debt service bur- income will continue to be the main driv- growth. The program rightly focuses on dens of the corporate sector, which has ers of poverty reduction in the context of macro stability with new tax legislation large foreign exchange exposures. These the strong increase in the minimum wage. and financial sector development, as well weigh heavily on private investment, Extreme poverty is projected to decline to as flexibility in the labor market by allow- along with a widespread perception of 2.6 percent in 2015 from 3.4 percent in ing more flexible contracts and reducing deteriorating institutional quality and 2013, while moderate poverty is slated to severance pay obligations. More is needed business climate. Firming activity in the decrease to 15.9 percent in 2015 from 18.6 to enhance the quality of regulatory insti- EU is helping exports, but Russian sanc- percent in 2013. tutions and strengthen the rule of law, in tions and security concerns will limit The poverty outlook is conditioned on the order to create a better environment for export growth and tourism revenue in role of the rising minimum wage. On one domestic and foreign investors and re- 2016. Economic growth is likely to slow hand, the population at the lower end of store investment growth in Turkey. to 3.5 percent in 2016. Increasing security the income distribution will benefit from a Inequality has recently stagnated. This is concerns and any deterioration of the rising real minimum wage, even if not important, as growth appears not to trans- political situation are the main downside formally employed, through its effect on late fully into higher incomes for the poor risks to our growth forecast. the overall wage structure. On the other in countries that are less equal. Continu- Low oil prices are helping to stabilize the hand, the move may lead to slower job ing to elevate the skill level of those at the current account deficit at around 4.6 per- creation in sectors that are unskilled labor lower end of the income distribution will cent of GDP. At the same time, the contin- intensive. As a result, the employment be important to boost the prospects of uing need for large capital inflows is a rate for younger or low-skilled workers making economic growth inclusive. Final- concern, amid difficult global financing may worsen disproportionately, and the ly, the labor market reform could have a conditions, and weakening Central Bank unemployment gap between skilled and progressive distributive incidence at the net reserves. The general government defi- unskilled workers could increase. margin since the potentially detrimental cit is likely to widen to 2.7 percent of GDP impact of higher minimum wages on job because of election promises and weaker creation is more binding for workers from revenue growth. However, the implica- tions on real government consumption Risks and challenges lower income households. will be limited given the nominal nature of election promises, such as increases in Medium-term growth prospects depend pensions and wage hikes. on the implementation of structural TABLE 2 Turkey / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 4.2 2.9 4.2 3.5 3.5 3.6 Private Consumption 5.1 1.4 4.4 5.1 4.0 3.8 Government Consumption 6.5 4.7 9.3 4.1 2.4 2.6 Gross Fixed Capital Investment 4.4 -1.3 1.1 2.1 3.5 4.9 Exports, Goods and Services -0.2 6.8 0.8 1.5 4.3 4.6 Imports, Goods and Services 9.0 -0.2 -0.7 4.5 5.1 5.8 Real GDP growth, at constant factor prices 4.9 3.3 4.2 3.5 3.4 3.5 Agriculture 3.5 -1.9 3.3 1.9 1.9 1.9 Industry 4.1 3.5 2.1 1.5 1.5 1.5 Services 5.5 4.0 5.5 4.8 4.6 4.7 Inflation (Consumer Price Index) 7.4 8.2 8.8 8.5 8.0 7.5 Current Account Balance (% of GDP) -7.9 -5.8 -4.5 -4.6 -4.9 -5.0 Financial and Capital Account (% of GDP) 7.5 5.4 3.1 4.3 4.6 4.7 Net Foreign Direct Investment (% of GDP) 1.1 0.7 1.6 1.3 1.4 1.5 Fiscal Balance (% of GDP) -0.7 -0.6 0.0 -2.7 -2.6 -1.8 Debt (% of GDP) 38.7 36.2 34.9 35.3 35.0 34.3 Primary Balance (% of GDP) 2.5 2.4 2.8 0.2 0.4 1.3 Poverty rate ($2.5/day PPP terms) a,b,c 3.4 3.2 2.7 2.3 2.0 1.7 Poverty rate ($5/day PPP terms) a,b,c 18.7 17.7 15.9 14.6 13.4 12.3 Sources: Wo rld B ank, M acroeco nomics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: e = estimate, f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2007-HICE, 201 2-HICE, and 201 3-HICE. (b) P rojectio n using point-to -po int elasticity (2007-2012) with pass-thro ugh = 1based o n GDP per capita co nstant P P P . (c) P o int-to -po int elasticity was the method o f choice, taking into co nsideratio n the lo cal co ntext. Years 2008-2009 were crisis years and wo uld pro vide a biased view if taken as baseline. MPO 81 Apr 16 Country Pages ●  115 firms. Given the limited monetary poli- TURKMENISTAN Recent developments cy tools available under the fixed ex- change rate arrangement, the fiscal adjustment helped to keep inflation The global decline in oil and gas prices low despite the devaluation’s pass - and weaker external demand from its through effect. major trade partners, including China, Turkmenistan does not produce an offi- Table 1 2015 slowed Turkmenistan’s economic cial poverty measure, and there are no Population, million a 5.4 growth to 6.5 percent in 2015, down targeted social assistance programs in GDP, current US$ billion a 43.6 from more than 10 percent a year in place to protect the vulnerable from GDP per capita, current US$ a 8118 2013 - 14. On the domestic demand side, external shocks. However, the govern- growth was supported by consump- ment is considering gradually transfer- Life Expectancy at birth, years b 65 tion and, to a lesser extent, by invest- ring from a universal public subsidy Sources: World Bank, WDI, and M acro Poverty Outlook. ments, although the government cut system to a more targeted, needs -based Notes: (a) World Bank staff estimates (2015). back some of its public investment in allocation system for social assistance. (b) Life Expectancy data show most recent WDI value (2013) 2015 to avoid increasing the fiscal defi- cit. On the supply side, growth was driven by retail trade and transport and communication. Outlook Oil and gas export earnings fell by nearly a half in 2015, leading to a dete- Turkmenistan is expected to face anoth- rioration of the external accounts. The er difficult year in 2016. Growth is pro- Turkmenistan’s growth slowed in 2015 authorities swiftly responded to the jected to slow further to 5 percent in shock by devaluating the Turkmen 2016 under a baseline scenario that as- due to declining world oil and natural gas manat by 18.6 percent against the U.S. sumes an average oil price of US$37 per prices and weaker external demand. In dollar in January 2015. However, the barrel and continued fiscal consolida- early 2015, the authorities made a one- current account closed the year with a tion. If hydrocarbon prices stay low, time adjustment to the exchange rate in an significantly higher deficit, estimated at they will adversely affect Turkmeni- 11.8 percent of GDP, compared with 6.7 stan’s GDP growth rate and its external effort to mitigate pressures on external percent in 2014. and fiscal balances. accounts. In view of declining revenues On the fiscal policy front, the govern- from the hydrocarbon sector, the authori- ment made a commendable effort to ties froze some public investment pro- improve spending efficiency, while freezing new large public investment Risks and challenges grams, while maintaining social spending. programs in light of declining revenue They are committed to structural reforms inflows. At the same time, the govern- Turkmenistan’s fiscal revenues and its aimed at diversifying the economy and ment maintained commitments to social balance of payments are highly depend- promoting more sustainable growth. spending and provided support to ent on external demand for its hydro- small -scale agriculture producers and carbon resources and on their prices on export - oriented and import - substituting global markets. Downside risks to our FIGURE 1 Turkmenistan / Real GDP growth and oil prices FIGURE 2 Turkmenistan / Nominal exchange rate and oil (Percent; US$/per barrel) prices (US$/TMT /US$ per barrel) US$ per barrel Percent US$ per barrel USD/TMT 0.38 120 16 120 0.36 14 100 100 0.34 12 0.32 80 80 10 0.30 8 60 60 0.28 6 0.26 40 40 4 0.24 20 20 2 0.22 0 0 0.20 0 2010 2011 2012 2013 2014 2015e 2010 2011 2012 2013 2014 2015 2016Q1 Nominal exchange rate, USD/TMT (LHS) GDP growth (LHS) Oil prices, Brent (RHS) Oil prices, Brent (RHS) Source: State Statistics Committee of Turkmenistan. Source: Central Bank of Turkmenistan. MPO 82 Apr 16 116  ●   World Bank ECA Economic Update April 2016 baseline scenario include a protracted Core domestic policy concerns center management, streamlining the role of oil glut, exacerbated by an increase of on increasing the Turkmen economy’s the state, and modernizing the public oil exports from Iran and/or the inabil- resilience to external shocks and ensur- sector administration with better insti- ity of Russia and the OPEC members to ing sustainable growth and job creation. tutional capacities. Turkmenistan’s top agree on potential production cuts. The However, low implementation capacity development priority is putting a sound Chinese economy’s slowdown and une- may hinder the acceleration of structur- and transparent system of public re- ven recoveries in the U.S. and Europe al reforms to diversify the economy, source management in place to ensure may also contribute to the continuation such as strengthening institutions and that its considerable natural resource of the oil glut. Besides weaknesses in creating appropriate skills and a level wealth will be efficiently used to im- international hydrocarbon prices, the playing field for the private sector. The prove basic living standards and re- potential spillover effects from Russia’s institutional reform agenda includes verse the recent deterioration in the continued recession and the Chinese improving the quality of fiscal deci- provision of social services. economy’s ongoing slowdown pose sions, strengthening efficiency of public risks and challenges for Turkmenistan. spending and overall public financial TABLE 2 Turkmenistan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f Real GDP growth, at constant market prices 10.2 10.3 6.5 5.0 Prices: Inflation 6.8 6.0 5.5 5.0 Current Account Balance (% of GDP) -7.2 -6.7 -11.8 -13.0 of which: Exports of oil and gas (% of GDP) 43.5 38.2 26.0 18.2 Financial and Capital Account (% of GDP) 14.5 8.6 8.2 7.4 of which: Net Foreign Direct Investment (% of GDP) 9.1 8.6 9.8 9.0 Fiscal Balance (% of GDP) 10.4 4.9 -1.0 -2.5 Debt (% of GDP) 21.1 16.8 21.0 22.0 So urces: Wo rld B ank, Internatio nal M o netary Fund. No tes: f = fo recast. MPO 83 Apr 16 Country Pages ●  117 moderate poverty (WB national method- UKRAINE Recent developments ology for Ukraine) is estimated to have increased from 15.2 percent in 2014 to 22.2 percent in 2015. Labor market condi- After a sharp contraction in economic tions deteriorated, with real wages down activity through the first three quarters by 13 percent y/y in December 2015 and Table 1 2015 of 2015, initial signs of stabilization unemployment remaining elevated at 9.5 Population, million 45.1 emerged in the fourth quarter. Real percent at end 2015. Poor households GDP contracted by 10 percent in 2015 were affected by the dramatic increase in GDP, current US$ billion 88.0 overall. The conflict has led to wide- energy prices in 2015, with the new GDP per capita, current US$ 1954 spread disruption in supply and distri- means-tested housing utility subsidy Poverty rate ($5/day 2005PPP terms) a 3.3 bution chains and undermined confi- program partly mitigating the impact. Gini Coefficient a 24.1 dence, while the drop in global com- The authorities adopted decisive policies b modity prices has led to a serious deteri- to reduce fiscal and external imbalances. School enrollment, primary (% gross) 106.0 oration of Ukraine’s terms of trade. Despite revenue losses from Donetsk and Life Expectancy at birth, yearsb 70.9 While the external economic environ- Luhansk, the headline fiscal deficit was Sources: World Bank WDI and M acro Poverty Outlook. ment remains difficult, the conflict in the reduced to 1.1 percent of GDP in 2015 Notes: east has de-escalated since September from 4.5 percent in 2014, due to tight (a) M ost recent value (2014) 2015 and macroeconomic and structural controls on spending and higher infla- (b) M ost recent WDI value (2013) reforms have begun to stabilize confi- tion. In addition, the Naftogaz deficit dence. As a result, real GDP contracted was reduced to 0.9 percent of GDP in The economy contracted by 10 percent in more modestly by 1.4 percent y/y in the 2015 from 5.6 percent in 2014 on the back 2015 due to unprecedented shocks from the fourth quarter of 2015, compared to 7.2 of tariff increases and lower prices of percent y/y in the third quarter and 16 imported gas. In November 2015, conflict in the East and lower global commod- percent y/y in the first half of 2015. In- Ukraine successfully restructured about ity prices, although initial signs of stabiliza- dustrial production declined by a more $15 billion of its public external debt. As tion emerged in the fourth quarter. A gradual modest 5 percent in the fourth quarter a result of these developments, public economic recovery is expected, contingent on and rebounded 7.6 percent in February and guaranteed debt stabilized at 82 per- reform progress and no further escalation of 2016. Inflation remained high at 43.3 cent of GDP in 2015, up from 70 percent percent y/y in December 2015 due to in 2014. In parallel, currency deprecia- the conflict. The general government deficit, currency depreciation and utility tariff tion, recession, and administrative con- including Naftogaz, was reduced to 2 percent hikes, but abated from a peak of 61 per- trols compressed imports and narrowed of GDP in 2015, although the fiscal outlook cent in April. the current account deficit to 0.2 percent remains challenging. Poverty is estimated to Poverty is estimated to have increased of GDP in 2015 from 3.5 percent in 2014. sharply in 2015. Disposable incomes Official disbursements amounted to have almost doubled in 2015 and is projected have contracted significantly from the $8.5 billion in 2015 and helped support to remain elevated through 2018 in light of deep recession. As a result, the poverty private debt repayments and an in- the gradual recovery, tight fiscal conditions, rate (under $5/day in 2005 PPP) is esti- crease in international reserves to $13.3 and further utility tariff increases. mated to have increased from 3.3 per- billion at end -2015, equivalent to 3.5 cent in 2014 to 5.8 percent in 2015, while months of imports. FIGURE 1 Ukraine / GDP growth, y/y, 2012-2015 FIGURE 2 Ukraine / Poverty Rates, actual and projected, 2007-2018 5 45 40 0 35 -5 30 -10 25 -15 20 -20 15 10 -25 5 -30 0 2012-Q1 2012-Q2 2012-Q3 2012-Q4 2013-Q1 2013-Q2 2013-Q3 2013-Q4 2014-Q1 2014-Q2 2014-Q3 2014-Q4 2015-Q1 2015-Q2 2015-Q3 2015-Q4 2007 2018 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Mining Manufacturing Domestic trade GDP $5/day PPP Moderate poverty Sources: Ukrainian Statistical Office and World Bank staff calculations. Sources: World Bank (see notes to Table 2). MPO 84 Apr 16 118  ●   World Bank ECA Economic Update April 2016 deficit to 3 percent of GDP in 2016 important to meet external financing Outlook (because of lower NBU profit transfers). Meeting this deficit target will prove chal- needs and rebuild international reserves. lenging, particularly in light of the payroll Prospects for economic recovery remain uncertain and depend on how the conflict tax rate cut from 40 to 22 percent in 2016. Estimates suggest that short term revenue Risks and challenges in the East unfolds and whether reforms losses could amount to 3 percent of GDP, on multiple fronts can be advanced in an which would require challenging compen- Ukraine will need to advance reforms on uncertain environment. If the conflict does satory measures to broaden the tax base, multiple fronts to achieve sustainable re- not escalate further and progress is made strengthen tax administration, and ration- covery and shared prosperity going for- on reforms, a gradual economic recovery alize current expenditures. If these chal- ward. First, in light of the difficult exter- is expected, with growth of 1 percent in lenging measures are successful, the fiscal nal environment and persisting vulnera- 2016 and 2 percent in 2017. The real depre- deficit is projected to narrow to 2 percent bilities, safeguarding macroeconomic sta- ciation coupled with efforts to tap the EU of GDP by 2018. bility will be critical. This will require market should support exports and trada- In line with the projected gradual econom- reforms to continue fiscal consolidation bles, while improved expenditure efficien- ic recovery, poverty is expected to decline and strengthen the financial sector, while cy should unlock public investment. Con- gradually in 2016-2018, although remain- maintaining a flexible exchange rate. Sec- tinued banking sector reforms should also ing above the level in 2014. Fiscal consoli- ond, Ukraine will need to improve permit a gradual resumption of lending. dation will require restraint on growth of productivity and create jobs by investing In the medium term, growth could pick public-sector wages, pensions, and other in infrastructure, improving the business up to 3-4 percent. The outlook is subject to social programs, as well as further energy climate, and taking advantage of trade serious risks, including an escalation of tariff increases, which will affect house- opportunities. Third, Ukraine will need to the conflict, further deterioration in the hold purchasing power across the income provide smarter and more effective ser- external environment, and difficulty to distribution. vices to the population to ensure that the advance reforms in the face of political Despite the narrowing of the current ac- benefits of recovery are broadly shared. instability. count deficit and restructuring of debt, Intensifying anti-corruption and govern- The fiscal outlook remains challenging external vulnerabilities are expected to ance reforms to reduce the influence of and has been shaped further by a far- persist. Ukraine will require significant vested interests will prove important reaching tax reform adopted together with external financing to meet repayments on across the board. the 2016 budget. The fiscal framework its external debt. Further cooperation with actually projects an increase in the fiscal the IMF and other official creditors will be TABLE 2 Ukraine / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2013 2014 2015 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 0.0 -6.6 -9.9 1.0 2.0 3.0 Private Consumption 6.9 -8.3 -20.2 -1.5 0.5 3.0 Government Consumption -0.9 1.1 1.0 1.0 1.5 1.5 Gross Fixed Capital Investment -8.4 -21.8 8.5 9.5 10.5 5.6 Exports, Goods and Services -8.1 -14.5 -16.9 2.2 5.0 4.0 Imports, Goods and Services -3.5 -22.1 -22.0 0.6 2.3 4.6 Real GDP growth, at constant factor prices 0.0 -6.6 -9.9 1.0 2.0 3.0 Agriculture 13.8 2.9 -4.7 0.7 1.5 2.0 Industry -3.8 -14.6 -13.5 1.4 2.8 3.0 Services -1.3 -4.2 -9.5 0.9 1.8 3.4 Inflation (Consumer Price Index) -0.3 12.1 43.3 12.2 8.0 6.0 Current Account Balance (% of GDP) -8.6 -3.5 -0.2 -1.3 -0.7 -1.0 Financial and Capital Account (% of GDP) 10.5 -6.7 1.1 -1.2 0.9 2.1 Net Foreign Direct Investment (% of GDP) 2.1 0.2 3.3 2.3 3.1 3.8 Fiscal Balance (% of GDP) -4.8 -4.5 -1.1 -3.0 -2.0 1.5 Debt (% of GDP) 40.7 71.1 81.6 80.4 79.8 78.2 Primary Balance (% of GDP) -2.3 -1.2 3.1 1.2 2.2 2.7 Poverty rate ($2.5/day PPP terms) a,b,c 0.1 0.0 0.1 0.1 0.1 0.0 Poverty rate ($5/day PPP terms) a,b,c 3.2 3.3 5.8 5.5 4.8 3.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 4-HLCS. (b) P ro jectio n using neutral distributio n (201 4) with pass-thro ugh = 1 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 3, 2014. P ro jectio ns are fro m 2015to 2018. MPO 85 Apr 16 Country Pages ●  119 dropped due to lower private consump- UZBEKISTAN Recent developments tion of durable goods and nonfood con- sumer items, as well as further import substitution by domestic fuel and chemical GDP grew at a rate of 8 percent in 2015 as production. The government tightened the government implemented a major foreign-exchange access to protect the ex- Table 1 2015 counter-cyclical fiscal policy in response ternal balance from deteriorating too rap- Population, million 31.1 to the deepening recession in Russia—one idly and to continue building international GDP, current US$ billion 66.9 of Uzbekistan’s largest trading partners reserves. and its primary source of remittances. A The national poverty rate declined from GDP per capita, current US$ 2151 substantial increase in public investment 14.1 percent in 2013 to 13.7 percent in 2014 Life Expectancy at birth, years a 68.1 drove growth on the demand side, while and reached an estimated 13.6 percent in Sources: World Bank, WDI, and M acro Poverty Outlook. business taxes were cut. These measures 2015. Robust economic growth, small- Notes: (a) M ost recent WDI value (2013). largely offset the impact of a worsening business development and targeted social external environment. However, personal assistance programs are driving poverty consumption hardly increased in 2015 due reduction. The distribution of income has to the erosion of real wages. become more equitable over time, and the The countercyclical stimulus package official Gini coefficient fell from 0.39 in caused the augmented fiscal surplus, 2001 to 0.29 in 2013. However, the unem- which includes the Fund for Reconstruc- ployment rate rose from 4.9 percent in tion and Development, to narrow from 2 2014 to 5.2 percent in 2015. percent of GDP in 2014 to an estimated 0.4 Despite the worsening external environ- percent in 2015. ment, Uzbekistan’s economy continued to A worsening regional economic environ- ment weakened the external accounts. The Outlook grow at a robust pace in 2015, supported current account surplus declined from 1.7 by a large fiscal stimulus package. While percent of GDP in 2014 to 0.9 percent in The average GDP growth rate is projected counter-cyclical fiscal policies are ex- 2015. Total exports declined by 5.3 percent to slow by almost one percentage point to during 2015 due to falling global commod- 7.2 percent during 2016-17. Low global pected to continue in 2016, growth is ity prices, slowing growth among Uzbeki- commodity prices, an ongoing decelera- projected to decelerate slightly, and re- stan’s major trading partners, and the real tion in China, and weak demand from turning migrants will increase pressure appreciation of the Uzbek som against key Russia and Kazakhstan are expected to on the labor market. The pace of poverty regional currencies. The sharp deprecia- drive this trend. Although prices for Uz- reduction is expected to slow over the tion of the ruble and declining real in- bekistan’s key commodities (except gold) comes in Russia caused inbound remit- are expected to slowly rise from 2017 on- medium term. tances to fall by 40 percent in 2015 in US wards, Uzbekistan’s main trading part- dollar terms to 4.9 percent of GDP from 8.6 ners are projected to recover only margin- percent of GDP in 2014. The weakening ally. However, as tight foreign-exchange Russian labor market also prompted many controls are expected to keep imports migrant workers to return. Imports subdued, the external accounts should FIGURE 1 Uzbekistan / Sectoral contributions to GDP FIGURE 2 Uzbekistan / Poverty, GDP per capita, and small growth, 2001-2015 business development, 2000–2015 10 GDP per Percent capita, US$ Small business, % of GDP 8 2,500 GDP per capita, US$, lhs 60 National poverty rate, % of population, rhs 6 2,000 50 40 1,500 4 30 1,000 2 20 500 0 10 2001 2003 2005 2007 2009 2011 2013 2015* Services Construction Agriculture 0 0 Industry Net taxes GDP total 2000 2002 2004 2006 2008 2010 2012 2014 Sources: Uzbekistan official statistics, World Bank staff calculations. Source: Official statistics from the Government of Uzbekistan. MPO 86 Apr 16 120  ●   World Bank ECA Economic Update April 2016 improve gradually over time. substantial share of commodity revenue commodities—gas, copper, gold and The government will continue to imple- and strengthen the economy’s resilience to cotton—or a more severe downturn ment expansionary policies to support the adverse shocks. among its main trading partners could economy. Increased public investment Improvements in the business climate for adversely affect export receipts, domestic under the newly adopted industrial, agri- micro- and small firms, including efforts consumption, the current account and the cultural and infrastructure development to expand their access to credit, will help fiscal balances. programs for 2015-19 is expected to sus- the labor market absorb returning mi- The government has recently launched a tain high rates of investment growth, grants. However, slowing income growth number of programs focusing on industri- while income tax cuts and public sector and a large influx of returning migrants al modernization, infrastructure develop- wage increases help to shore up private will limit progress in reducing unemploy- ment and agricultural productivity. These consumption. However, Uzbekistan’s ment, poverty and inequality over the initiatives could significantly boost Uz- restrictive trade and foreign-exchange near term, with all three expected to re- bekistan’s long-term growth potential if regimes, the monopolization of certain main broadly unchanged through 2018. complemented by more ambitious struc- sectors by state-owned enterprises, and tural reforms aimed at supporting a ro- frequent power outages caused by deteri- bust and competitive private sector, en- orating infrastructure are projected to progressively diminish the return on in- Risks and challenges hancing economic efficiency and promot- ing more inclusive grow. vestment under the baseline scenario. The government is expected to maintain its Uzbekistan’s economic outlook is sub- commitment to prudent fiscal policies, ject to significant downside risks. A fur- which will enable it to continue saving a ther decline in prices for its key export TABLE 2 Uzbekistan / Selected economic indicators (annual percent change unless indicated otherwise) 2013 2014 2015 e 2016 f 2017 f 2018 f Real GDP growth, at constant market prices 8.0 8.1 8.0 7.3 7.2 7.2 Private Consumption 4.8 5.8 -0.5 -0.3 3.5 5.0 Government Consumption 5.9 9.9 8.4 3.1 2.0 2.9 Gross Fixed Capital Investment 10.7 9.6 9.5 9.3 9.4 10.0 Exports, Goods and Services 8.3 -5.1 -5.3 -2.8 0.2 2.6 Imports, Goods and Services 5.9 -4.1 -13.4 -6.9 -5.3 1.1 Real GDP growth, at constant factor prices 9.4 8.0 9.0 7.5 7.2 7.2 Agriculture 6.8 6.9 6.8 6.6 6.5 6.5 Industry 6.0 5.7 5.8 4.5 4.0 4.2 Services 12.0 9.3 11.1 8.9 8.4 8.4 Inflation (Private Consumption Deflator) 10.2 10.0 10.0 9.0 8.0 8.0 Current Account Balance (% of GDP) 2.9 1.7 0.9 0.8 0.9 1.0 Fiscal Balance (% of GDP) 2.5 2.0 0.4 0.3 0.6 0.7 Debt (% of GDP) 8.5 8.3 10.5 15.6 14.1 12.2 Primary Balance (% of GDP) 2.6 2.1 0.5 0.4 0.8 0.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 87 Apr 16 na on Europe and Central Asia The Impact of Chin Europe and Central Asia Economic Update Office of the Regional Chief Economist April 2016 The economies of Europe and Central Asia (ECA) are facing complex challenges. In the eastern part of the region the task of governments is to orchestrate a coordinated crisis response. The collapse of oil revenues and the associated decline in remittances triggered a chain reaction of shocks. Adjustment to these shocks requires a new monetary policy regime, resolution of serious fragilities in banking sectors, fiscal reforms that put government finances on a sustainable path, while guaranteeing fair burden sharing, and facilitation of job creation in sectors that compete internationally. In the western part of the region policy coordination within the European Union is being tested by the refugee crisis and a possible Brexit. Meanwhile the Chinese economy has slowed down and is in the process of fundamental transformation. Also these developments have major impacts on the ECA region. The report analyses all these challenges and points at the opportunities to become more competitive in global markets. ISBN (electronic): 978-1-4648-0912-5 2016 International Bank for Reconstruction and Development / The World Bank Some rights reserved 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org