99668 BIA SER AND A NIA BOS EGOVIN Z HER O EGR OVO TEN KOS MON NIA EDO MAC FYR ANIA ALB Report No. 99668-ECA South East Europe Regular Economic Report No.8 Growth Recovers, Risks Heighten Fall 2015   Acknowledgments This Regular Economic Report (RER) covers economic developments, prospects, and economic policies in six South Eastern European countries (SEE6): Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. The report is produced twice a year by World Bank staff economists working on the SEE6 countries. The team of authors comprises Gallina A. Vincelette (task team leader and lead author), Anil Onal (lead author), Barbara Cunha (lead author), Ashley Taylor (lead author), Agim Demukaj, Aida Gjika, Sandra Hlivnjak, Sanja Madžarević-Šujster, Suzana Petrović, Lazar Šestović, Hilda Shijaku, and Bojan Shimbov. Maria Davalos, Trang Van Nguyen, Cesar A. Cancho, Alexandru Cojocaru, Monica Robayo and William Seitz prepared the regional poverty trends (Spotlight); Anil Onal (lead author) and Johannes Koettl the note on aging (Special Topic); Ilias Skamnelos, Johanna Jaeger, and Jane Bogoev contributed to the financial sector boxes; Anna Raggl and Pegi Yilli provided inputs on demographic and migration issues. Anne Grant provided assistance in editing, and Budy Wirasmo and Robert Waiharo in designing this report. Valentina Martinovic, Nejme Kotere, Samra Bajramovic, Ivana Bojic, Enkelejda Karaj, Hermina Vukovic Tasic, Jasminka Sopova, Boba Vukoslavovic, and Dragana Varezić assisted the team. Dissemination of the report and external and media relations are managed by an External Communications team of Lundrim Aliu, Anita Božinovska, Paul A. Clare, Ana Gjokutaj, Jasmina Hadžić, Elena Karaban, Artem Kolesnikov, Andrew Kircher, Vesna Kostić, John Mackedon, Mirjana Popović, and Sanja Tanić. The team is grateful to Ellen Goldstein (Country Director, South Eastern Europe), Satu Kähkönen (Director, Macroeconomics and Fiscal Management Global Practice), Ivailo Izvorski (Practice Manager, Macroeconomics and Fiscal Management Global Practice) and the South Eastern Europe Country Management team for their guidance in preparation of this report. The team is also thankful for comments on earlier drafts of this report received from SEE6 Central Banks and Ministries of Finance. This and previous SEE RERs may be found at: www.worldbank.org/eca/seerer. Standard Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data presented in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Copyright Statement: The material in this publication is copyrighted. Copying or transmitting portions or all of this work without permission may be a violation of the law. The International Bank for Reconstruction and Development/The World Bank encourages dissemination of its work and will normally grant permission promptly to reproduce portions of the work. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978- 750-4470, http://www.copyright.com/. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail pubrights@worldbank.org. SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Contents Overview1 1. Strengthening Economic Recovery 7 Investment Boost to Growth  9 Favorable International Economic Dynamics  13 Economic Growth Gaining Momentum, but with Medium-term Risks  18 2. Policies for Income Growth and Competitiveness 23 Mixed Progress on Fiscal Consolidation 25 Pressures on Monetary and Exchange Rate Policies  27 Asset Quality Concerns and Financial Sector Support for Growth  29 Structural and Demographic Issues  33 Spotlight: Poverty Trends and Expected Developments 39 Poverty Trends 41 Labor Markets and Poverty 42 Poverty Outlook 44 SEE6 Country Notes 47 Albania49 Bosnia and Herzegovina 54 Kosovo60 FYR Macedonia 66 Montenegro72 Serbia78 SEE6: Key Economic Indicators 85 vi  | Contents GROWTH RECOVERS, RISKS HEIGHTEN List of Figures Figure 1.1: After a year of stagnation, the economies of SEE6 are recovering in 2015 9 Figure 1.2: While recovering investment drives growth… 10 Figure 1.3: ...the contribution of net exports remains limited 10 In most of the SEE6, employment, while improving, remains below pre- Figure 1.4:  crisis levels… 12 Figure 1.5: ...and the unemployment rate is stubbornly high 12 Figure 1.6: Labor market participation is low, especially for women… 12 Figure 1.7: …and almost half of the youth labor force is unemployed 12 Figure 1.8: SEE6 income growth since 2008 has been higher than the EU average,… 13 ...but faster income convergence to the EU requires a sharp improvement Figure 1.9:  in growth rates 13 Figure 1.10: Major export partner growth pick up moderately, but remain well below pre-crisis levels 15 Figure 1.11: Most of the region has benefited from declining oil import prices 15 Figure 1.12: Marked depreciation of exchange rates against the dollar and the euro 15 Figure 1.13: Real effective exchange rate movements have been more muted 15 Figure 1.14: Current account imbalances have largely narrowed since 2008… 16 Figure 1.15: …but the adjustment is stalling in 2015 16 Figure 1.16: US dollar yields have exceeded euro yields, although both have picked up recently 17 Figure 1.17: External public debt has picked up since 2011 17 Figure 1.18: Exposure to depreciations against the dollar is limited, except in Serbia 17 Figure 1.19: Currency weakness has offset some of the declines in global commodity price indices 18 Figure 1.20: Energy price inflation has been less volatile while food price inflation started to fall 18 Figure 2.1: Fiscal imbalances remain high in 2015 27 Figure 2.2: Fiscal consolidation with mixed results in SEE6 in 2015 27 Figure 2.3: The fiscal burden of wage and social spending, including pensions, is significant 27 Figure 2.4: High levels of public debt rise further in 2015 27 Figure 2.5: The sizeable rise in NPLs following the financial crisis have yet to be addressed 29 Figure 2.6: Private credit growth in the region is generally muted  31 Figure 2.7: Income convergence of the SEE6 with the EU has slowed… 33 Figure 2.8: …as growth in the region has stalled since the global financial crisis  33 Working age emigrants from Albania and Serbia tend to be better Figure 2.9:  educated than their counterparts at home 36 Figure S.1: Economic Growth and Poverty 41 Figure S1.2: Household Income by Source in SEE6 43 Contents  |  vii SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 List of Figures (continued) Albania49 Real GDP, annual growth rates and Economic Sentiment Indicator 49 Fiscal Revenues, Expenditures, and Overall Balance 50 Sectoral contributions to GVA growth (production side) 52 Monetary aggregates 52 Confidence Survey indicators 52 Headline inflation  52 Unemployment and Employment 52 Public Debt 52 CAD, FDI and other investments 52 Bosnia and Herzegovina 54 Selected Financial Soundness Indicators 56 Real GDP growth 58 Agriculture, manufacturing and energy 58 Consumer prices 58 VAT58 General government fiscal balance 58 Exports and imports 58 Real and nominal effective exchange rate index 58 Share of foreign-currency indexed loans in total loans 58 Kosovo60 Real GDP Annual Growth Rates, Kosovo, 2008–15 60 Growth in Aggregate Demand, 2011–14 64 Growth in the Economy by Sector, 2010–14 64 Current Account Balance and FDI, 2011–15 64 General Government Deficit 64 Annual Growth in Loans, 2012–15 64 General Government Debt, 2008–14 64 Nonperforming Loans, 2008–15 64 CPI and PPI. 2011–14 64 viii  | Contents GROWTH RECOVERS, RISKS HEIGHTEN List of Figures (continued) FYR Macedonia 66 Contribution to GDP growth by sectors 66 Business tendencies in the manufacturing industry 70 Labor market developments 70 CPI and its main components 70 Current account balance, trade deficit and private transfers 70 Central Government budget execution 70 Public debt by government levels 70 Credit growth and contribution to credit growth 70 Non-performing loans 70 Montenegro72 Real GDP, annual growth rates 72 Current account balance 73 High frequency data, trend-cycle adjusted series 76 External trade 76 Labor market, administrative data 76 General government deficit 76 Labor market, survey-based data 76 General government debt 76 Loans and deposits, annual growth 76 CPI and PPI, annual growth rates 76 Serbia78 Real GDP Growth 79 Inflation80 Industrial output growth 82 Unemployment rate 82 Nominal loan growth 82 Export value growth 82 Quarterly fiscal deficits 82 Government debt-to-GDP 82 Contents  |  ix SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 List of Tables Table 0.1: Expectations for sustained recovery of growth sustained through 2017 3 Table 1.1: The recovery in growth is projected to be sustained through 2017 19 Macro dynamics are challenging for monetary policy management in non- Table 2.2:  euro countries 28 Table B2.4.1: Economic Reform Programs for SEE6, 2015 37 SEE6: Key Economic Indicators 87 List of Boxes Box 1.1: The Economic Cost of Gender Gaps in SEE6  11 Figure B1.1: Gender Gaps and Income per Capita 11 Figure B1.2: Income per Capita by Age Group 11 Box 1.2: SEE6 and Migration  21 Box 2.2. Safeguarding Financial Stability in SEE6 30 Box 2.3. Options for solvent and profitable Greek Subsidiaries 32 Box 2.4: EU Council Conclusions on SEE6 Economic Reform Programs  37 x  | Contents Overview GROWTH RECOVERS, RISKS HEIGHTEN Economic activity in the six South East age people are in the labor force; and at less than European countries (SEE6) is picking up 40 percent, female labor force participation is speed, and growth in the region is expected even lower. Youth unemployment in the region to average 1.8 percent for 2015.1 The is about 45 percent, which has not only near- highest growth rates projected are 3.4 percent and longer-term economic costs, but also social for Montenegro and 3.2 percent for FYR consequences. Macedonia; the lowest is Serbia’s 0.5 percent. Although they trail the rest of the SEE6 Table 0.1: Expectations for sustained recovery region, Serbia and Bosnia and Herzegovina, of growth sustained through 2017 which were hit heavily by floods in mid-2014, Real GDP Growth, 2014–17 are recovering faster than expected. As 2015 2014 2015f 2016f 2017f progresses, a recovery in domestic demand is Albania 2.1 2.7 3.4 3.5 stimulating economic growth throughout the Bosnia and 0.8 1.9 2.3 3.1 Herzegovina region. Private investment has become the Kosovo 1.0 3.0 3.5 3.7 main driver of growth. Developments in the Macedonia, FYR 3.8 3.2 3.4 3.7 global economy have also helped, especially Montenegro 1.5 3.4 2.9 3.0 lower oil prices and a pick-up in demand in the European Union (EU), a major market for the Serbia -1.8 0.5 1.5 2.0 region. SEE6* 0.3 1.8 2.4 2.8 Source: National statistical offices and World Economic Outlook (2015). Note: *This is a weighted average. While the recovery has encouraged job creation, unemployment is still very high, especially for the young. Employment With few jobs being created and high rates of throughout the region is slowly picking up, informality, poverty reduction throughout but it is above 2008 precrisis levels only in the SEE6 has been lackluster since 2008. FYR Macedonia and Montenegro. In Serbia Households rely heavily on pensions, social and FYR Macedonia, with growth firming assistance, and transfers, which constitute half of up, the employment rate has moved up to their incomes. The fiscal costs of social spending 42 percent in Q2 2015, the highest level are significant, averaging 13.4 of GDP. At the since Q2 2009 in each country. Despite same time, considerable opportunities exist these positive development, unemployment, for making current programs more efficient, which averaged 21.6 percent in Q2 2015, is mainly by targeting benefits more effectively, still a central structural issue for the region. and reallocating funding to new programs or Real wages are rigid, limiting the flexibility of more pressing needs. economies to respond to adverse shocks, while high and sticky unit labor costs jeopardize SEE6 medium-term growth prospects are competitiveness. Informal labor markets are positive. The regional growth rate is forecast common. Only about 50 percent of working- to rise to an average 2.6 percent in 2016–17, stimulated by recovering domestic demand and low oil prices, but moderated by tightening 1 The SEE6 are Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. global financing conditions and a slowing Overview  |  3 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 global growth trajectory. Within the aggregate efforts should continue to: address structural SEE growth picture, country diversity is budget rigidities; prioritize and rationalize marked, with the Serbian economy growing expenditures toward productive investments more slowly than the others in the near term. and raising the quality of public services; clear As discussed in the Spotlight on poverty trends, public arrears; improve revenue collection; with the return of economic growth, poverty broaden the tax base; and reduce the labor tax is expected to decline. Overcoming structural wedge. With regional inflation low and output weaknesses in the labor market of SEE6 will gaps evident in almost all SEE6 economies, help sustain poverty reduction in the region there is some scope for short-term monetary easing, especially in countries where fiscal There are risks to this overall positive outlook deficits have begun to decline. However, care in both directions. In the near term, lower must be taken to ensure consistency with oil prices are expected to continue to support external balances to avoid the risk of adverse emerging growth in the EU economies. In currency movements, which could put the medium term, moderate global demand pressure on corporate, household, and public and tighter financing conditions are expected balance sheets, particularly where much debt is to slow the region’s growth trajectory relative denominated in foreign currencies. Addressing to the period leading up to 2008. Moreover, high nonperforming loans (NPLs)—at international financial markets remain 16 percent of total loans on average—is critical turbulent, though concern has shifted from the to ultimately release the flow of credit to mid-year heightening of the crisis in Greece, support business and job creation. During the which had limited spillovers to the region, to summer proactive financial sector regulations the timing of U.S. interest rate rise and the and communications inoculated the SEE6 outlook for China’s economy. Attention of against contagion from the Greek financial policymakers in the region, and in the EU, has crisis. The possibility of further deleveraging also turned to the challenge of rising transit and of more adverse swings in international migration through the region to the EU. financing conditions calls for sustained efforts Domestically, political cycles and the realization to keep national finances stable. of planned structural and fiscal reforms may have both upside and downside effects on the While macroeconomic stability is necessary outlook. for sustained income growth, it is not sufficient; structural issues must be tackled Carefully prioritizing economic policies so that the SEE6 countries can accelerate is essential to manage these risks. At close growth and restart their EU convergence to 4 percent on average, fiscal deficits are process. From 2000 to 2007, growth in the worrisome when public debt is rising rapidly. SEE6 moved average income per capita up from Sustained reforms are needed to ensure 23 percent of the EU average to 31 percent on a macrofiscal sustainability, particularly as purchasing power parity (PPP) basis. However, financing conditions tighten, and to expand the rate of convergence has since stagnated. SEE6 the space for using fiscal policy to mitigate income has on average grown by only 1 percent future shocks. Among other goals, reform annually since the global financial crisis crested. 4  | Overview GROWTH RECOVERS, RISKS HEIGHTEN Vigorous structural reforms will be needed to from abroad, attenuating not only the effects broaden the SEE6 growth outlook. Like the of aging, but also positively contributing to the macrofiscal policy agenda, the structural reform quality and quantity of human capital in SEE6 agenda is multipronged: stimulate employment and ultimately increasing potential growth of by eliminating disincentives and barriers to the region. formal jobs, support investment by improving governance and the business environment, and deepen international integration and connectivity. It also requires that public services and social protection systems be made more efficient and more equitable. Resilience can also be promoted by sustainable use of energy and natural resources and by careful stewardship of the environment. Over time growth in the region will continue to be affected by such demographic factors as the aging and shrinking of societies across the region. Today, the average inhabitant is already 13.5 years older than the global average and the United Nations projects that the difference will widen to 21.1 years in the next 50 years. Today, on average in SEE6 there are 2 old-age dependents for every 10 working- age people; by 2060, the projection is for 7.6 dependents per 10 working-age people. The UN also projects that the population will have shrunk by 25 percent. As productive capacity similarly shrinks, the demographic transformations may hurt growth and are likely to intensify pressure on public finances. However, it is possible to mitigate part of the negative effects with responsive policies and with adjustments in the behavior of individuals and firms. And opportunities may well arise from incentives, for example, to increase labor force participation, invest more in building human capital across the region and slowing the trends of emigration. Creating income generating opportunities provides incentives for young individuals to stay or return home Overview  |  5 1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN Investment Boost to Growth As economic activity picks up in the six has been primarily driven by domestic demand, South East European countries (SEE6) both consumption (especially in Bosnia and growth in the region is expected to average Herzegovina and Kosovo) and investment 1.8 percent for 2015.2 The highest growth throughout SEE6. Private investment has rates expected are 3.4 percent for Montenegro been picking up across the region as credit and 3.2 percent for FYR Macedonia; the lowest growth recovers and more retained earnings is the projected 0.5 percent for Serbia. Although are invested. In every SEE6 country private trailing the rest of the SEE6 region, Serbia investment has been contributing to growth. and Bosnia and Herzegovina, are recovering The pace of public investment has also picked faster than expected from the floods of 2014. up as governments carry out capital projects, This publication’s regional growth projections often financed by international financial for 2015 have been revised upwards (from institutions (IFIs). However, fiscal restraints on the 1.3 percent expected in the January 2015 current public spending and continuing labor RER to 1.8 percent), mainly because domestic market weakness are suppressing consumption demand has been higher than was expected. growth throughout the region. Figure 1.1: After a year of stagnation, the Low energy prices, weaker currencies, and economies of SEE6 are recovering in 2015 tepid economic prospects in Europe are also Real GDP growth, 2014 and 2015, percent supporting growth in SEE6. Albeit from a 4 3.4 lower base, exports continue to grow faster than 3.2 3 2.7 3.0 imports on average. Goods exports as a share of 1.9 1.9 GDP are expected to go up by 2.9 percentage 2 1.8 points in Serbia and 1.3 percentage points in 1 0.5 FYR Macedonia. Exports in these two countries 0 are growing on the back of strong FDI- supported industrial products (automobiles -1 and electrical machinery) as well as domestically- -2 owned steel and food exports in Serbia. Growth ALB BIH KOS MKD MNE SRB SEE6 EU28 prospects in the EU28, a key export partner for JJ 2014 JJ 2015f Source: World Bank staff estimates based on data from national statistical the SEE6, are showing a slight pickup from offices and Eurostat (2015). 1.5 percent in 2014 to 1.9 percent this year. Low oil prices and consequently reduced Domestic investment is driving growth in import bills, are helping narrow external 2015. Starting in the second half of 2014, growth imbalances throughout the region except for Albania, where oil exports amount to about a quarter of total goods exports. However, 2 The SEE6 are Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. adverse weather conditions (floods in 2014 and 1. Strengthening Economic Recovery  |  9 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 droughts in 2015) have reduced 2015 Despite the positive development, the agricultural, and to a lesser extent energy, slow pace of adjustment reflects structural exports across the region, limiting the problems in SEE6 labor markets. Despite contribution of exports to growth. variations by country and sector, real wage rigidities mean that changes in employment are The SEE6 labor markets are gradually the main channel for labor market adjustment recovering. Employment numbers are slowly to shocks. Sticky unit labor costs have picking up across the region. Employment undermined competitiveness, and informal is already above precrisis levels in FYR labor markets are common. Despite a slight Macedonia and Montenegro. In Q2 2015, pickup of 0.6 percentage points in 2014, Serbian employment moved up to 42.3 percent regional labor force participation rates are low and the FYR Macedonian employment to by international standards: only 50 percent of Figure 1.2: While recovering investment drives Figure 1.3: ...the contribution of net exports growth… remains limited Decomposition of real GDP growth, 2014–15, percentage points Contribution of net exports to real GDP growth, 2014–15, percentage points 7 8 6 6 5 4 4 3 2 2 0 1 0 -2 -1 -4 -2 -6 -3 -4 2014 2015f 2014 2015f 2014 2015f 2014 2015f 2014 2015f 2014 2015f -8 2014 2015f 2014 2015f 2014 2015f 2014 2015f 2014 2015f 2014 2015f ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ Consumption JJ Investment JJ Net exports QQ Real GDP growth (percent) JJ Imports JJ Exports QQ Net exports Source: World Bank calculations based on data from national statistical Source: World Bank staff calculations based on data from national offices. statistical offices. 41.7 percent, the highest level in each country working-age individuals are active. At less than since Q2 2009. Unemployment is also slowly 39.1 percent, female participation is even lower. falling; the regional average is down from The gender gap also helps to explain lagging 22.9 percent in Q2 2014 to 21.6 percent in income per capita in SEE6 (see Box 1.1). Youth Q2 2015. The largest improvement over this unemployment is about 45 percent for the period, 2.6 percentage points, has been in region; the result is both near- and longer-term Serbia. What is notable is that most of the jobs economic costs and social consequences. were created in the formal private sector, while government continued its fiscal consolidation Modest improvements in labor market and restructuring of state-owned enterprises performance are only slowly rising living (SOEs). standards in the SEE6, which remain below precrisis levels. Some countries in the region 10  |  1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN Box 1.1: The Economic Cost of Gender Gaps in SEE6 Labor force participation rates in SEE6 are less than 50 percent, about 10 percentage points lower than the EU average. Participation is particularly low among women at participation rates averaging just 40 percent, compared to close to 60 percent for men. The gender gap in the region is largest in Kosovo, where only 21.4 percent of women were active in the labor market in 2014. The gender gaps in labor participation and entrepreneurship represent a missed opportunity for lifting income per capita in SEE6. Cuberes and Teignier (2015) estimate that the magnitude of “lost” income per capita due to gender differences in SEE6 averages about 17 percent, with the income loss highest in Kosovo at over 28 percent. These SEE6 income losses have widened since the global financial crisis. The estimated average loss in income per capita in SEE6 due to gender gaps is significantly higher than the 10.5 percent estimate for the EU. About a third of the estimated lost income per capita is due to distortions in the occupational choices for women and men; the rest is due to costs associated with gender inequalities in labor force participation. Though gender gaps are prevalent in all groups, gaps by age vary within SEE6 (World Bank 2012) and have implications for the evolution of the labor market. In SEE6, Cuberes and Teignier (2015) calculated that income losses in SEE6 because of gender gaps are highest among those aged 36–50 and the minimal labor market activity of women in that group are largely responsible for the missed income opportunities due to labor market gender inequalities. Figure B1.1: Gender Gaps and Income per Figure B1.2: Income per Capita by Age Capita Group Percent Percent 30 100 80 20 60 40 10 20 0 2008 2012 2013 2012 2007 2011 2007 2006 2010 0 2008 2012 2013 2012 2007 2011 2007 2006 2010 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ Due to labor force participation gap JJ Due to occupation choice JJ Age 15–24 JJ 25–35 JJ 36–50 JJ 51–65 Source: Cuberes and Teignier 2015. Note: A counterfactual set of gender gaps for each age group is calculated. To get the fraction of income loss for each age group, the aggregate gender gap is computed as if all the gender gaps were zero except for that particular age group. References: Cuberes, David and Marc Teignier. 2015. “How Costly Are Labor Gender Gaps? Estimates for the Balkans and Turkey. World Bank Policy Research Working Paper Series (forthcoming). Washington, DC. World Bank. 2012. “World Development Report 2012: Gender Equality and Development.” Washington, DC. 1. Strengthening Economic Recovery  |  11 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 are tentatively resuming poverty reduction, but Weak growth in the SEE6 since the 2008 the effects of the 2008 global financial crisis global financial crisis has stalled income and subsequent recessions in the region have convergence of its incomes with the EU. yet to fade (see Spotlight). As recovery picks up, SEE6 income has had average annual growth of poverty is expected to decline slowly. Growth just 1 percent since 2008. While average growth will help SEE6 to return to the precrisis levels in the region is still better than in the EU, there and pace of poverty reduction. are significant differences within it. Growth in Figure 1.4: In most of the SEE6, employment, Figure 1.5: ...and the unemployment rate is while improving, remains below pre-crisis stubbornly high levels… Employment Index, Q2 2008=100 Unemployment rate, percent 120 40 115 35 110 30 105 25 100 20 95 15 90 85 10 80 5 75 0 08 09 10 11 12 13 14 15 Q2- Q2- Q2- Q2- Q2- Q2- Q2- Q2- ALB BIH KOS MKD MNE SRB SEE6 ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ SEE6 JJ Q2 2008 JJ Post-crisis peak Q2 2008 QQ Q2 2015 Sources: World Bank staff calculations based on national statistical offices. Sources: World Bank staff calculations based on national statistical offices. Note: The regional total excludes Kosovo. Note: Kosovo is as of 2014. Regional average is weighted and excludes Kosovo. Figure 1.6: Labor market participation is low, Figure 1.7: …and almost half of the youth especially for women… labor force is unemployed Activity rates as percent of population over 15 years of age, Youth unemployment rate, 2014, percent 2014 80 70 70 60 62.9 60.1 60 53.0 50 50 47.0 45.8 40 40 35.8 30 32.5 30 20 21.9 20 10 10 0 0 ALB BIH KOS MKD MNE SRB SEE6 EU28 ALB BIH KOS MKD MNE SRB SEE6 EU28 Percent of labor force (15–24) QQ Male QQ Female Sources: National statistical offices and Eurostat 2015 data. Source: National statistical office data. Note: Kosovo data is for population aged 15–64. Note: Albania data is for labor force aged 15–29, and therefore biases the Albania and the regional average down. Data may not be directly comparable across countries due to underlying data sources. 12  |  1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN Albania, FYR Macedonia, and Kosovo 23 percent of the EU average; propelled by compares well with fast-growing EU countries strong economic growth, it reached 31 percent like Poland and Lithuania; but in Serbia, in 2008. However, the 2008 global financial Montenegro, and Bosnia and Herzegovina, crisis and the subsequent slow growth in the incomes are only 1–2 percent higher than in SEE6 not only put poverty reduction on hold, 2008—very close to the performance of crisis- they also slowed income convergence with the impacted EU and OECD countries. In 2000, EU. average SEE6 income per capita stood at Figure 1.8: SEE6 income growth since 2008 Figure 1.9: ...but faster income convergence has been higher than the EU average,… to the EU requires a sharp improvement in growth rates Real GDP per capita in 2014 relative to 2008 SEE regional PPP GDP per capita, international dollars, 2011 prices, relative to EU average, percent Poland 100 Albania Kosovo 90 Lithuania FYR Macedonia 80 Romania 70 Bulgaria SEE6 60 Latvia Germany 50 United States Bosnia and Herzegovina 40 OECD Serbia 30 Montenegro EU28 20 Italy Croatia 10 Greece 0 2% 4.5% 6% 75 100 125 2013 average annual growth until 2035 Real GDP per capita index (2008=100) Source: World Bank calculations based on data from national statistical Source: WDI and World Bank calculations. offices and World Economic Outlook (2015). Note: EU real GDP per capita (PPP) assumed to grow by 1 percent per annum on average over 2014 to 2035 for purposes of illustration. SEE average is weighted by PPP GDPs. Favorable International Economic Dynamics Recent economic outcomes in SEE6 have external balances, inflation, government been influenced by three major developments budgets, and public debt dynamics. in the global economy:  gradual pick-up in activity in the EU, falling global oil prices since First, the recent growth recovery in main mid-2014, and the weakening of the euro and trading partners had a positive effect on strengthening of the U.S. dollar. These trends SEE6 exports. The growth rates of the region’s have fed into the economies of SEE6 through major trade partners (weighted by export 1. Strengthening Economic Recovery  |  13 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 shares) have been moving up steadily. The 576 million in the year through July-2015 EU28 economic growth increased from from EUR 729 million a year earlier. 1.5 percent in 2014 to a projected 1.9 percent in 2015, which is reflected on the region’s Third, exchange rates in the region continue imports. In the first half of 2015 real EU28 to track closely the depreciation of the imports, on aggregate, rose year-on-year by euro against the U.S. dollar (Figure 1.12).3 4.5 percent (5.2 percent in Q2 2015; Differences in U.S. and Euro Area monetary 3.7 percent in Q1 2015), after growing policy and the consequent higher U.S. 3.3 percent (year-on-year) in the second half of bond yields have contributed to a marked 2014. This demand has been refracted in the strengthening of the dollar against the euro growth in SEE6 exports to the EU28 through in 2014 and the first half of 2015. For SEE6 2015. For example, in the first seven months of countries with floating exchange rates and fixed 2015 Serbia’s exports to the EU grow by rates to the euro, there has been a significant 9.8 percent year-on-year, moving up the EU’s nominal depreciation against the US dollar of share in total Serbian goods exports over the about 12 percent for Albania, FYR Macedonia, period to 66.8 percent from 66.1 percent a year and euro countries; and about 9 percent for earlier. Services exports from Montenegro have Serbia since December 2014. This brings been especially strong over the same period, average nominal depreciation of currencies with tourism performance growing by over in the region against the US dollar to about 12 percent. The rise in SEE6 exports is still 25 percent since 2013. Movement against modest with the goods exports increasing by a the euro for the region’s floating currencies, projected 1.1 percentage points of GDP to has been limited. As in many other emerging reach 25.5 percent of GDP as average growth economies, the real exchange rate impact of rates of major trading partners are barely half of the dollar’s appreciation was only moderate, those seen before the crisis and are expected to with the currencies of Bosnia and Herzegovina, increase only gradually. In this context, it is FYR Macedonia and Serbia exhibiting a real critical to pursue measures to increase depreciation of about 3-4 percent so far in competitiveness and diversification of the SEE6 2015 (Figure 1.13). The price movements do exports. not seem large enough to significantly boost trade, especially considering lags in other Second, falling global oil prices are helping competitiveness factors, such as relatively large improve trade balances for SEE6 net oil logistics costs.4 importers. Except for Albania, the SEE6 countries are not major oil producers, and lower oil prices translated to lower import costs for this economies. Oil imports-to-GDP ratios range from 4 to 8 percent (2013 data) and are significant relative to overall current account deficits in many SEE6 countries. In Serbia, for 3 See the World Bank June 2015 Global Economic Prospects for example, the import oil bill declined to EUR further analysis of these trends. 4 See latest IMF surveillance country reports on the SEE6 countries, at www.imf.org. 14  |  1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN Figure 1.10: Major export partner growth pick Figure 1.11: Most of the region has benefited up moderately, but remain well below pre-crisis from declining oil import prices levels Real GDP growth, percent Oil imports to total exports and GDP, percent; current account deficit to GDP, percent, 2013 data 8 16 6 14 4 12 2 10 0 8 -2 6 -4 4 -6 2 -8 0 2006 2008 2010 2012 2014 2016 ALB BIH MKD MNE SRB JJ SEE6 range ▬▬ EU growth ▬▬ Growth in SEE ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ SRB Source: IMF Direction of Trade Statistics and World Economic Outlook; Source: Central banks and IMF data, World Bank calculations. World Bank calculations. Note: Increase is an appreciation. Note: Major export partner growth calculated as average of export partner growth rates weighted by identified export shares (shares updated annually; with 2014 weights used for 2015 and 2016 projections). Min-max range for SEE6 excludes Kosovo because of lack of data. Figure 1.12: Marked depreciation of exchange Figure 1.13: Real effective exchange rate rates against the dollar and the euro movements have been more muted Appreciation as of July 2015 percent Real effective exchange rate index 100=January 2012 5 110 0 105 -5 -10 100 -15 -20 95 -25 -30 90 2 2 2 2 3 3 3 3 4 4 4 4 5 ALB MKD SRB EURO 1/1 4/1 7/1 10/1 1/1 4/1 7/1 10/1 1/1 4/1 7/1 10/1 1/1 JJ Vs US dollar since Dec 2014 JJ Vs US dollar since Dec 2013 ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ SRB JJ Vs Euro since Dec 2014 JJ Vs Euro since Dec 2013 Source: Central bank and IMF data. World Bank calculations. Source: Central banks and IMF data, World Bank calculations. Note: The Euro bar includes BIH, KOS, and MNE. Exchange rate data as Note: Increase is an appreciation. of April for Macedonia vs US dollar and March vs euro. Monthly average exchange rates. The current account rebalancing that took averaging a weighted 18.6 percent of GDP in place after the global financial crisis has 2008. Even though current account deficits stalled. The domestic demand-driven pre-crisis have narrowed significantly since the crisis growth model resulted in high external (Figure 1.14), they have widened slightly in the imbalances, with current account deficits past two years to 7.3 percent of GDP in 2014 1. Strengthening Economic Recovery  |  15 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 and a projected 6.7 percent in 2015. The EU accession agenda has given impetus to projected slight improvement in 2015 relative reforms across SEE6. In this respect if to the previous year comes from Serbia where successfully implemented, reforms may boost export performance is expected to surpass the FDI inflows to the region. For example, FDI increase in imports, leading to an improved inlows to Serbia and Bosnia and Herzegovina, trade balance by 2 percentage points of GDP which are likely to see increases of 0.2–0.3 (Figure 1.15). Trade imbalances are expected to percent of GDP in 2015. narrow in the rest of the SEE6 too, but due mostly to declining imports rather than a External debt has expanded in the recent strong export performance. Aggregate current years as the governments of SEE6 countries transfers are projected to decline across the took advantage of the lower yields. Rising SEE6 in 2015, partly reflecting the effects of external debt ratios are thus common in almost Figure 1.14: Current account imbalances have Figure 1.15: …but the adjustment is stalling largely narrowed since 2008… in 2015 Current account deficit, percent of GDP Contribution to change in current account deficit in 2015 relative to 2014, percent of GDP 50 5 45 4 40 3 35 2 30 1 25 0 20 -1 15 -2 10 -3 5 -4 0 -5 ALB BIH KOS MKD MNE SRB SEE6 ALB BIH KOS MKD MNE SRB JJ 2008 JJ 2015f JJ Goods imports JJ Goods imports JJ Net services exports JJ Remittances JJ Others QQ Change in current account deficit Source: World Bank calculations based on data from central banks and Source: World Bank calculations based on data from central banks and national statistical offices. national statistical offices. the unfolding developments concerning Greece all SEE6 countries, especially for the public in the summer and partly the fragility of the sector (Figure 1.17).5 This dynamic has been growth prospects in the region and the rest of driven by a strategy of taking advantage of the Europe. yields on external financing being lower than on domestic, whether in U.S. dollars or more Remittance and foreign direct investment recently in euros. External debt ratios in the (FDI) inflows are increasing moderately with improvements in domestic and external 5 Interestingly, as highlighted in the June World Bank Global economic conditions. The weighted average of Economic Prospects, the global picture for developing economies remittance inflows to the SEE6 is expected to as a group is one in which private external debt has gone up noticeably but sovereign external debt only moderately, with a shift increase by 0.5 percent of GDP in 2015. The toward domestic borrowing. 16  |  1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN Figure 1.16: US dollar yields have exceeded denominated in dollars (Figure 1.18). Higher euro yields, although both have picked up external debt raises refinancing risks, especially recently as tighter external financing conditions and Yield, percent 7 further currency depreciation are likely. For 6 example, Serbia’s projected 2016 gross external financing need is equivalent to 16.6 percent of 5 GDP, and in Montenegro it reaches 16 percent. 4 Rising interest costs will also amplify the 3 burden of interest payments, particularly for 2 countries with a high share of debt issue at floating rates. 1 0 4 4 4 14 5 5 5 Inflation in the region is low. Three major 1/1 4/1 7/1 10/ 1/1 4/1 7/1 ▬▬ Emerging market gov. yield (US dollar index), Europe region developments are affecting inflation dynamics ▬▬ US Treasury 10-yr gov. yield (US dollar) this year. First, after a slight pickup early in ▬▬ Emerging market gov. yield (Euro index), Europe region ▬▬ Euro area 10-yr gov. yield (Euro) 2015, international oil prices are gradually Source: Data from JP Morgan, Eurostat, and the Federal Reserve Board of ebbing to the levels seen in year-end 2014. the United States. Note: The emerging market index is JP Morgan Emerging Market Bond Second, so far, as mentioned, SEE6 exchange Index global. rates against the U.S. dollar have moved in an SEE6 have risen by an average of 6 percent of offsetting direction, muting the local currency GDP since 2011 (the range is from 0.4 to gains of lower international commodity prices. 13 percent of GDP). In 2014, exchange rate Finally, to a large extent administered energy depreciations against the dollar also pushed up prices and tax regimes in the SEE6 have limited external debt, especially for Serbia–a country pass-through of changes in international prices. with a relatively high share of debt that is For instance, relative to their peak in June Figure 1.17: External public debt has picked Figure 1.18: Exposure to depreciations against up since 2011 the dollar is limited, except in Serbia External debt as a share of GDP, percent Currency share of public and publicly guaranteed external debt 2014, percent 140 100 90 120 80 100 70 80 60 50 60 40 40 30 20 20 2011 2015f 10 2011 2011 2011 2011 2011 2011 2015f 2015f 2015f 2015f 2015f 2015f 0 0 ALB BIH KOS MKD MNE SRB SEE6 ALB BIH KOS MKD MNE SRB JJ Private debt JJ Public and publicly guaranteed debt JJ US$ JJ Euro JJ SDR Source: Ministries of Finance and central banks. Source: World Development Indicators, national authorities. Note: 2013 data for Bosnia and Herzegovina and FYR Macedonia. 1. Strengthening Economic Recovery  |  17 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 2014, in January 2015 international crude-oil 0.2 percent due to increasing food prices. In prices were down by almost 60 percent year- Bosnia and Herzegovina and Serbia there were on-year in U.S. dollar terms, 50 percent in euro unusually high seasonally-adjusted increases in terms, and 47 percent in Serbian dinars. For the prices of unprocessed fruit, vegetables, and the same period, the energy component of the meat. Food inflation began to decline in Q2 CPI declined by an average of only 0.4 percent 2015. In Montenegro, higher domestic demand across the SEE6 (10.8 percent in Bosnia and pushed up prices by 1.5 percent in the first Herzegovina), while overall inflation was seven months of 2015. Figure 1.19: Currency weakness has offset Figure 1.20: Energy price inflation has been some of the declines in global commodity price less volatile while food price inflation started indices to fall Local currency value of international commodity prices (Jan Inflation year-on-year, percent 2013=100) A. International Energy B. Food Prices Prices 140 15 120 10 100 5 80 0 60 40 -5 3 3 3 4 4 5 3 3 3 4 4 5 11 2 12 3 13 4 14 5 1/1 6/1 11/1 4/1 9/1 2/1 1/1 6/1 11/1 4/1 9/1 2/1 12- 6-1 12- 6-1 12- 6-1 12- 6-1 ▬▬ ALB ▬▬ MKD ▬▬ SRB ▬▬ EURO ▬▬ USD ▬▬ CPI inflation ▬▬ Food CPI inflation ▬▬ Energy CPI inflation Source: National central banks, IMF, World Bank calculations. Source: National central banks, IMF, World Bank calculations. Note: U.S. dollar commodity price indices (World Bank) converted to local Note: Inflation rates weighted by PPP value of GDP. currency using average monthly exchange rates. Economic Growth Gaining Momentum, but with Medium-term Risks In 2016–17, SEE6 growth is expected to rise Although domestic demand is not likely to to a broad-based 2.6 percent. External factors rebound to pre-2008 levels, in the near term such as oil prices stabilizing at current levels private investment is expected to continue to and a gradual build up in external demand, firm up across SEE6. Real disposable incomes including from the pick-up of growth in the of households and firms are expected to inch up Euro Area growth, will support economic as inflation stays low, oil stabilizes at relatively activity in the region. low prices, some countries clear arrears, 18  |  1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN and investment projects funded by foreign the crisis in Greece, which had little spillover to investors and the EU get underway. However, the region, to how and when the United States the region is still burdened by some of the will raise interest rates and the outlook for highest NPLs in Europe. Confidence could China’s economy. Thus the main external risks build if governments in the SEE6 launch and for the SEE6, as they are for other developing consistently sustain planned structural reforms. economies, are an upswing in financial volatility As economic growth takes hold, employment globally and protracted slow growth and the should gradually increase, but more slowly. potential for deflationary pressures from the Euro Area.6 Attention of policymakers in the Table 1.1: The recovery in growth is projected region, as in the EU, has also been turning to to be sustained through 2017 the challenge of rising migration flows through SEE6 regional 2014 2015f 2016f 2017f the region to the EU. The main domestic risks averages, percent of GDP unless are a slow and tenuous recovery of the credit otherwise stated supply, uncertainties related to political cycles, Real GDP growth 0.3 1.8 2.4 2.8 and delays in planned structural reforms, such (percent) as fiscal consolidation and privatization. Each Consumer price 0.8 1.5 .. .. key group of risks is discussed in turn: inflation (percent, period average) Public revenues 34.6 34.8 34.1 33.8 yy Volatile financial flows: Persistent Public expenditures 38.4 38.6 37.8 36.7 strength in the U.S. dollar–euro exchange Fiscal balance -3.8 -3.9 -3.7 -3.0 rate and a related reassessment of emerging Public and publicly 51.7 55.7 55.7 55.1 market fundamentals could cause capital guaranteed debt to flow out of the region, which would Goods exports 24.4 25.5 .. .. hit countries with significant dollar- Trade balance -17.3 -15.8 .. .. denominated debt the hardest. Financial Current account -7.3 -6.7 -6.5 -6.4 market volatility may also be associated balance with the U.S. move to normalize its External debt 61.1 64.1 67.6 67.8 monetary policy. Possible foreign Non-performing 15.8 15.6 .. .. bank deleveraging also carries a risk of loans (percent of gross loans) financial outflows, and there is the risk Unemployment rate 22.4 21.7 .. .. that depreciations of national currencies (percent, period could lead to balance sheet pressures for average) Source: World Bank staff calculations based on data from national borrowers with unhedged foreign currency statistical offices and central banks. Note: Weighted averages by PPP adjusted GDP except for fiscal and liabilities. financial indicators, which reflect simple averages. yy Protracted slower global growth, The projected upswing in the SEE6 outlook especially in the EU: Since the positive has downside risks, both external and domestic. International financial markets remain turbulent, although the focus of concern 6 See World Bank. 2015, June. Global Economic Prospects–The Global Economy in Transition. http:// www.worldbank. org/content/dam/ has shifted from the mid-year heightening of Worldbank/GEP/GEP2015b/ACS.pdf. 1. Strengthening Economic Recovery  |  19 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 growth forecast for SEE6 hinges on expected to be almost 40 percent lower in external factors, especially a rebound in 2017 than they were in 2013.9 Persistently the EU, a slower than expected recovery lower prices and economic slack heightens would reduce exports to and investment the risk of second-round effects through from the EU.7 While the base case is for lower nominal wage growth, which could the EU recovery to build in 2015 and entrench disinflationary pressures. 2016, as domestic demand builds in the SEE6 the downside risks are significant. yy Domestic politics and a less supportive For example, a deeper contraction of fiscal stance: High debt and record-high economic activity in Russia and Ukraine NPLs will continue to dampen SEE6 could cloud the prospects for EU growth. economic prospects unless there is marked This would raise indirect economic risks progress on structural reforms. The SEE6 for the SEE6, though more from the effect are vulnerable to political instability, which on consumer and investor confidence than may jeopardize current reform momentum any direct costs. There are also broader and dilute government intentions to move risks emanating from the global economy, on long-needed reforms to consolidate for example, that excessive depreciation public finances, address rigidities in the of the U.S. dollar would dampen U.S. capital and labor markets, refine legal growth prospects or the low-probability systems, and restructure remaining event that China’s gradual rebalancing of SOEs, especially public utilities. Cost growth carries a steeper-than-anticipated to government budgets may be incurred decline in investment.8 from managing the rising transit migration through SEE6 to the EU (see Box 1.2). yy Movement of global oil prices: Though lower oil prices would dampen the inflation outlook in SEE6, it might also support the trade balances of oil importers and domestic economic activity through lower input costs. Despite their recovery earlier this year, oil prices are projected to decline by 40 percent for the year, after falling by an average of 7.5 percent in 2014. Even though they are expected to pick up in 2016 and 2017, global oil prices are still 7 For further analysis of the outlook for the EU see World Bank. 2015. EU Regular Economic Report: Modest Recovery, Global Risk. http://www.worldbank.org/content/dam/Worldbank/document/ eca/eu-rer-1-eng.pdf. 8 For detailed discussion of global risks see World Bank. op. cit., note 7. (2015), Global Economic Prospects – The Global Economy in Transition, June http://www.worldbank.org/content/dam/ 9 According to the World Bank projections of average crude oil spot Worldbank/GEP/GEP2015b/ACS.pdf. prices. 20  |  1. Strengthening Economic Recovery GROWTH RECOVERS, RISKS HEIGHTEN Box 1.2: SEE6 and Migration The SEE6 countries are among the top migrant-sending regions in the world. Today the equivalent of a quarter of the current population of SEE6 lives outside their home countries. In the course of two decades, the share of the region’s emigrants in their source country population doubled from 13 percent in the 1990s to over 25 percent in 2013. Since the early 1990s, there has been a steady flow of migrants from the SEE6 to the EU with roughly 4.9 million people, having left their countries. In contrast to the early 1990s when refugees fled the war-ridden territories of the former Yugoslavia, in the last two decades, migrants from the SEE6 have been predominately economic migrants. Low growth since the global financial crisis, chronically high unemployment, income levels at a third of the average of the EU, and vulnerability to external shocks and natural disasters, have constrained domestic income generation in the region. As such, people continue to emigrate in search of better economic opportunities. The majority of migrants are young, of working age, and generally with higher educational attainment than the respective age group in the home countries. Still, about one third of high-skilled emigrants from the SEE6 work in blue-collar or unskilled occupations in their host countries. The last two decades of emigration have influenced the economic performance of the SEE6 countries. Remittances, almost 10 percent of GDP in SEE6 economies per year, have supported consumption and current account inflows. Migrants play a role in facilitating trade and investment. However, outmigration may negatively impact a country’s human capital, while the fiscal impact is mixed. The significant influx of people from the Middle East, Asia and Africa seeking refuge and economic opportunities in the EU has dominated recent headlines. According to the FRONTEX, the EU border agency, the EU has received more than 500,000 migrants between January and August 2015 compared to 280,000 people in the entire 2014. While this is a large inflow of individuals to the region, it is a very small portion of the EU28 population. It is uncertain how long recent trends will last and how they would affect migrants from the SEE6 in the host EU countries. Most migrants from the SEE6 leave their countries for economic reasons. Economic migrants move to where the jobs are. With an increased flow of new migrants in the EU, there is likely to be an increased demand for jobs in the host country. The extent will depend on the relative skills of and their substitutability among migrants from the SEE6 and any other groups of workers as well as the location of jobs offered, among other factors. Understanding the possible impact of changing migrant composition on individual migrants groups as well as on the host country labor market is important. While there is currently no comprehensive empirical work, it is clear that, the supply of labor migrants bring (regardless of their origin) could partly fill labor gaps in the host country and soften the effects of a shrinking and aging European population on the economy in the medium to long term. Finally, the new wave of people seeking refuge in the EU, following a transit through the SEE6 region can also affect the region’s economies. For now, the SEE6 region is not a final destination for the migrants from the Middle East, Asia and Africa; instead, it is just a transit area. However, this can change, as traditional host countries review immigration policies and border controls, and deal with the current large backlog of over half a million asylum applications in the EU. Migrants may see an increase in the time spent in transit through the Western Balkans, which in turn could increase costs to the transit countries governments. 1. Strengthening Economic Recovery |  21 2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN Maintaining sound economic policy already low by historical standards there is a management and advancing structural need for caution to ensure consistency with reforms are essential to ensure that the external balances and limit the risk of adverse economic recovery is resilient and that currency movements, which could put pressure growth prospects improve. On the fiscal side, on corporate, household, and public sector given rising public debt and tighter financing balance sheets, particularly where much debt conditions, sustained discipline would be key is denominated in foreign currency. Similarly, in keeping government balances in check. To in the financial sector, addressing high NPLs ensure that recovery is resilient, it is essential is critical to restarting the growth of credit, to address structural rigidities in SEE6 supporting entrepreneurship and job creation, budgets and clear fiscal space for mitigating and reinforcing the ability to deal with future the effects of any new shocks. Policies should pressures. For example, the possibility of continue to be channeled to, among other further foreign bank deleveraging or adverse areas, redirecting public spending away from shocks to international financing conditions generous public wages and ill-targeted social calls for sustained efforts to guard financial assistance into productive investment; targeting stability. During the summer proactive and prioritizing expenditures; clearing financial sector regulation inoculated the SEE6 public arrears; improving revenue collection; against contagion from the Greek financial broadening the tax base; and reducing the labor crisis. Demographic and structural issues are tax wedge. As for monetary policy, with regional suppressing growth potential; unless addressed inflation low and output gaps in almost all they will continue to slow SEE6 income per SEE6 economies, there is scope for short-term capita gains. Vigorously pursuing structural easing of monetary conditions, especially in reforms while keeping the economy stable countries whose deficits have begun to decline. will provide the needed stimulus to potential However, in countries where policy rates are growth. Mixed Progress on Fiscal Consolidation Fiscal deficits in SEE6 are still high in 2015, than-previously-expected performance. In despite consolidation efforts (Figure 2.1). The addition to successfully clearing a large stock of largest deficit reduction from 6.7 percent of public arrears and in the conditions of GDP in 2014 to 4 percent of GDP in 2015 is underperforming revenues relative to being undertaken by Serbia. The deficit expectations, Albania expenditure cuts are the reduction there is driven primarily by decreasing main drivers of the reduction in the fiscal deficit public sector wages and pensions, while strong in 2015. Fiscal imbalances in the rest of SEE6 revenue performance, particularly from non- countries, except Montenegro, are also expected tax revenues, have contributed to the stronger- to narrow, albeit less noticeably. Fiscal revenues 2. Policies for Income Growth and Competitiveness  |  25 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 are driving consolidation efforts in FYR Fiscal consolidation in SEE6 will not Macedonia and Kosovo, despite be effective if countries in the region do underperforming initial budgets. In Bosnia and not address structural rigidities in their Herzegovina and Montenegro, fiscal revenues government budgets. With interest rates are expected to decline in 2015 relative to low and little room for monetary policy to 2014. Efforts to improve revenue performance, respond to shocks, fiscal policy becomes the widen the revenue base and professionalize tax primary tool for smoothing fluctuations in administration are expected to lead to structural economic activity. Building fiscal buffers improvements in public finances in SEE6. should be a priority if SEE6 governments are Fiscal deficits are expected to widen in to provide room for fiscal policy responses and Montenegro, due to a massive increase in support improved public sector performance capital spending related to a large highway and service delivery. Among numerous policy construction project. measures to reinforce the sustainability of public finances are (1) containing expenditures Public and publicly guaranteed debt in SEE6 while changing their composition away from continues to inch up. Since 2008 public debt wages toward more productive and equitable has risen not only in Albania, Montenegro, and areas; (2) increasing fiscal transparency and Serbia, which have the highest debt-to-GDP strengthening budget management with ratios at about 70 percent, but also in the rest of credible fiscal rules, medium-term expenditure the region. To finance persistent fiscal deficits, frameworks, and more stringent management average public debt, including guarantees, went of debt, guarantees, and contingent liabilities; up by almost 20 percent of GDP between 2009 (3) ensuring long-term budget sustainability by and 2015. With inflation low across the SEE6, reforming pension and related social benefits reducing the debt-to-GDP ratios has become as well as targeting the large public sector; (4) even more difficult. Thus far, interest costs have clearing arrears and preventing their build- not put much pressure on public debt because up; and (5) improving revenue collection and the monetary policies of advanced economies broadening the tax base while reducing the are still accommodative. Nevertheless, Serbia labor tax wedge. among other economies has seen its debt ratios rise as the U.S. dollar strengthened. While in the short term benchmark sovereign yields may stay low, particularly in the Euro Area with European Central Bank quantitative easing, they have moved up recently, feeding through into emerging market yields. Global interest rates are bound to rise after monetary stimulus ends, which would imply for the SEE6 economies higher costs in managing and refinancing their debt. As mentioned above, during the transition, there are likely to be periods of heightened volatility. 26  |  2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN Figure 2.1: Fiscal imbalances remain high in Figure 2.2: Fiscal consolidation with mixed 2015 results in SEE6 in 2015 Fiscal deficit to GDP, percent Contribution to annual change in fiscal deficit in 2015, percent of GDP 7 5 4 6 3 5 2 4 1 3 0 -1 2 -2 1 -3 0 -4 ALB BIH KOS MKD MNE SRB SEE6 ALB BIH KOS MKD MNE SRB SEE6 JJ 2014 JJ 2015f JJ Expenditure JJ Revenue QQ Change in fiscal deficit Source: Ministries of Finance. Source: Ministries of Finance. Figure 2.3: The fiscal burden of wage and Figure 2.4: High levels of public debt rise social spending, including pensions, is further in 2015 significant Percent of GDP Percent of GDP 35 90 80 30 17.0 70 25 14.1 17.7 60 15.0 13.4 20 50 15 11.3 40 5.4 12.2 30 10 11.9 9.3 9.1 9.1 20 5 7.1 5.1 10 2015 2015 2015 2015 2015 2015 2015 2014 2014 2014 2014 2014 2014 2014 0 0 ALB BIH KOS MKD MNE SRB SEE6 ALB BIH KOS MKD MNE SRB SEE6 JJ Wage bill JJ Social benefits JJ Public debt JJ Publicly guaranteed debt Source: Ministries of Finance. Source: Ministries of Finance. Pressures on Monetary and Exchange Rate Policies In the current domestic and global makers in the region need to support growth environment, monetary policy-makers are and generate employment while pursuing fiscal confronted by a range of challenges  (Table consolidation. Meanwhile, the effects of 2.2). With overall inflation generally low,  shifting patterns of global capital flows and partially due to low import prices, policy concerns about the quality of domestic bank 2. Policies for Income Growth and Competitiveness  |  27 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 assets need to be carefully managed, while 2012 to an average of 8.7 percent in 2013– solidly anchoring inflation expectations. 14—above the 2008 level. In FYR Macedonia, Persistent unemployment in SEE6 has meant though the increase was from 1.5 to 3.3 percent that the traditional short-term Philips curve of GDP, FDI was still below that of 2008. In trade-off between unemployment and inflation Serbia, where the current account deficit is is not observed. Indeed for a number of lower, an accommodative monetary policy has countries, unemployment has fallen along with mainly been exercised through reductions in inflation. headline rates and management of inflation expectations. Throughout the region policy SEE6 is absorbing the impact of the recent rates are at historical lows. euro depreciation. The depreciation primarily affects Bosnia and Herzegovina, which has The limited room for monetary policy a currency board regime; and Kosovo and flexibility adds impetus to the momentum Table 2.2: Macro dynamics are challenging for monetary policy management in non-euro countries Percent Fixed Policy Inflation Actual Real GDP Unemployment Fiscal Current Exchange Rate Target Inflation Growth Rate Deficit Account Rate or (2015f) (2015f) (2015f) to GDP Deficit-to-GDP Euro (2015f) (2015f) ALB n 2.0 2-4 2.1 2.7 17.1 5.1 13.1 BIH y 0.5 1.9 27.5 1.9 7.9 KOS y -0.5 3.0 35.3 2.5 8.2 MKD n 3.25 0.4 0.5 3.2 27.4 3.9 2.8 MNE y 1.0 3.4 17.6 5.9 16.0 SRB n 5 2.5–5.5 2.5 0.5 17.9 4.0 4.0 Source: Data from national authorities. Note: FYR Macedonia has a de jure floating exchange rate. However, the National Bank of the Republic of Macedonia (NBRM) applies exchange rate targeting as a monetary policy strategy and participates in the foreign exchange market in order to maintain a stable exchange rate with a narrow fluctuation band vis-à- vis the euro. The de facto exchange rate regime is a stabilized arrangement, according to classification of IMF. Montenegro, which have unilaterally adopted for fiscal consolidation. Building up fiscal the euro. In Albania and FYR Macedonia, buffers for deployment against future shocks given their current account deficits and can help Albania, FYR Macedonia and Serbia unemployment ratios, the flexibility to adjust to use the limited monetary policy room more policy depends in part on the quality of effectively to support growth. However, any external financing; longer-term FDI is likely to loosening in monetary conditions should be be less sensitive to shifts in short-term interest accompanied by continued efforts to improve rate differentials. In fact, in the last two years financial stability so as to limit, for example, both countries have been able to finance any rise in financial and corporate risk-taking an increasing share of their current account and any deterioration in credit quality. deficits through FDI. In Albania, net FDI inflows went up from 6.8 percent of GDP in 28  |  2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN Asset Quality Concerns and Financial Sector Support for Growth Figure 2.5: The sizeable rise in NPLs following activity and growth. A decomposition of the financial crisis have yet to be addressed interest rate spreads demonstrates the toll NPL Non-performing loans to total loans, percent provisioning exerts on lending and profitability, 30 although operational inefficiencies are still the 25 predominant factor.10 20 NPL resolution is a problem throughout the 15 region. Montenegro is the only SEE6 country 10 that has been able to bring NPLs down to where they were before the global financial crisis.11 5 While all SEE6 governments are making efforts 0 to tackle the NPL issue in their countries, most ALB BIH KOS MKD MNE SRB SEE6 JJ Q2 2015 QQ Q4 2007 ‹‹ Post-crisis peak recently two countries have shown progress: Sources: Central banks. Serbia has adopted a specific strategy and action plan for resolving problem loans; and in Kosovo, a private bailiff system helping to The SEE6 region is heavily burdened by enforce collateral recovery has helped push NPLs, which are the highest in Europe. By the share of NPLs down from 8.3 percent in July 2015, on average in SEE6 NPLs stood at December 2014 to 7.1 percent in July 2015.12 15.8 percent of total loans—triple what they were pre-crisis (Figure 2.5). Within the region 10 Interest rate spread is the difference between the lending and Albania and Serbia have the highest NPLs at deposit rate. It can be decomposed (from an accounting identity) over 20 percent. Ineffective legal systems are into profits, provisions, overheads, and reserves for each of the SEE6 countries. Interest rate spreads vary across SEE6, with among the main obstacles preventing banks spreads in Kosovo (at 9 pp) significantly exceeding the regional average. They are lowest in Bosnia and Herzegovina and Serbia from enforcing collection against defaulted at 4.3 and 4.4 percent respectively. The interest rate spread in most SEE6 countries is driven by operating costs and provisions borrowers and realizing on collateral. The associated with the deterioration in banks’ asset quality in the wake weaknesses relate specifically to such factors as of the global financial crisis. Only in Kosovo and Albania does the profit margin play a significant role, accounting for around a third the corporate and personal insolvency regimes of the total spread. 11 Montenegro recently adopted a law on voluntary financial and creditor rights, along with ambiguity about restructuring called the “Podgorica approach.” It allows for out-of- selling NPLs. Moreover, tax law discourages court restructuring of economically viable companies, e.g., through purchases of debtors’ claims supported by tax and supervisory write-off, restructuring, or sale of NPLs, and incentives. Further measures will now be necessary to ensure that banks share information and pursue a harmonized strategy for there is no law allowing corporate out-of- recovery from common borrowers. This is best done with backing court debt restructuring. If unresolved, NPLs from a strong, independent sponsor, such as a central bank or government agency. In August 2015, parliament also adopted a will continue to burden bank balance sheets, law for conversion of Swiss franc loans into euros; it affects one bank and 600 clients with indexed loans totaling some €30 million undermine profits and capital, and suppress (0.8 percent of GDP). The whole amount of the exchange rate bank consideration of new lending—and differences have to be equally shared among the borrowers, the bank and the state. more generally bank ability to boost economic 12 See http://www.nbs.rs/internet/english/55/npl/action_plan.pdf. 2. Policies for Income Growth and Competitiveness  |  29 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 In addition to high NPLs, both supply and While in general banks in the SEE6 are demand factors affect the slow recovery of well-capitalized and liquid, other factors growth of credit. Post-crisis tightening of may directly affect the stability of the SEE6 credit standards and the deterioration in parent financial sector: bank funding conditions have reduced the supply of credit throughout SEE6. Moreover, yy Stocks of foreign exchange loans to since the crisis fragile economic growth and unhedged domestic borrowers—at least limited corporate deleveraging have suppressed half of all borrowers—are high in SEE6. demand for credit. With economic growth As of mid-2015, for example, the average firming up in 2015, credit growth has been share of foreign-current-denominated relatively strong in FYR Macedonia and has loans in Serbia was close to 65 percent. picked up gradually in Kosovo, Albania, and Montenegro. In Bosnia and Herzegovina and yy There are also risks to financial stability Serbia, credit growth has been subdued (Figure related to external borrowings under 2.6). tighter international financing conditions and the possibility of abrupt shifts in exchange rates. Box 2.2. Safeguarding Financial Stability in SEE6 The midsummer 2015 Greek crisis tested the stability of SEE6 financial sectors. There are three Greek bank subsidiaries in Albania, two in Macedonia, and four in Serbia, which all share the characteristics of purely domestic banks. They constitute 12 to 22 percent of sector assets in these countries; in all three they are well-capitalized, liquid, not reliant on parent funding, and constitute a small share of parent assets. The Greek bank subsidiaries are independent legal entities rather than branches of the parent bank and are thus separately capitalized. Although currently stable and not in need of external funding, the recent events highlighted that persistent uncertainties related to evens in Greece may still trigger adverse fallout. The authorities complemented previous ring-fencing actions with temporary measures to mitigate contagion and safeguard stability. All three countries intensified their monitoring and deployed proactive communication strategies. In Albania, the regulator continued to impose higher capital requirements and limited the dividends subsidiaries could pay to parent banks. The Bank of Albania issued an order prohibiting commercial banks to transfer money to banks in Greece. In FYR Macedonia, the Central Bank adopted temporary precautionary measures to restrict capital outflows to Greek entities. The authorities also required FYR Macedonian banks to withdraw all loans and deposits from banks based in Greece and their branches and subsidiaries in Greece or abroad, regardless of the agreed maturity. The Central Bank of Serbia formulated contingency plans, including liquidity support, and required banks to limit transactions with Greek parents. Notably, the Serbian banking crisis management regime has recently been aligned with EU standards; the changes introduced a separate structure and tools for resolving systemically important domestic banks. With the help of a World Bank project, the Deposit Insurance Fund has been strengthened and the top 12 banks are undergoing an Asset Quality Review. 30  |  2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN Figure 2.6: Private credit growth in the region is generally muted Credit growth year-on-year, three month moving average, percent 40 30 20 10 0 -10 -20 9 0 1 2 3 4 5 9 0 1 2 3 4 5 9 0 1 2 3 4 5 1/0 1/1 1/1 1/1 1/1 1/1 1/1 1/0 1/1 1/1 1/1 1/1 1/1 1/1 1/0 1/1 1/1 1/1 1/1 1/1 1/1 JJ ALB nominal ▬▬ ALB real JJ BIH nominal ▬▬ BIH real JJ KOS nominal ▬▬ KOS real 40 30 20 10 0 -10 -20 9 0 1 2 3 4 5 9 0 1 2 3 4 5 9 0 1 2 3 4 5 1/0 1/1 1/1 1/1 1/1 1/1 1/1 1/0 1/1 1/1 1/1 1/1 1/1 1/1 1/0 1/1 1/1 1/1 1/1 1/1 1/1 JJ MKD nominal ▬▬ MKD real JJ MNE nominal ▬▬ MNE real JJ SRB nominal ▬▬ SRB real Sources: Central banks, IMF, World Bank calculations. Note: Real credit growth is calculated as ex post real growth based on CPI inflation. The three-month moving average is the average of growth rates year-on- year. yy Developments in Greece may continue to  n general, financial policy in SEE6 should I add stress to SEE6 financial systems, as be directed to ensuring that deposit insurance the June-July 2015 crisis demonstrated. schemes are adequately funded and there are Despite proactive measures by SEE6 recovery and resolution plans for systemic authorities (see Box 2.2) there was banks in place. some impairment of confidence, resulting in limited depositor outflows from Greek subsidiaries. However, the deposit withdrawals remained within the banking systems, being transferred to other local banks. Looking ahead, with the closing of the Greek banking system and the economic deterioration in Greece, authorities are concentrating on understanding the possibilities for future ownership structure of Greek-owned subsidiaries (see Box 2.3). 2. Policies for Income Growth and Competitiveness  |  31 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Box 2.3. Options for solvent and profitable Greek Subsidiaries The upcoming completion of the Asset Quality Review for the Greek parent banks will bring back into the spotlight the issue of the ownership structure of Greek-owned subsidiaries. Greek banks are likely to downsize international operations, similarly and in continuation of agreements under the EC restructuring plans of 2014. The closing of the Greek banking system and economic deterioration in Greece suggests that its parent banks may seek or accelerate the divestment of their solvent subsidiaries in the region. Such actions could be hastened by ECB stress tests and as part of upcoming recapitalization packages. If Greek parent banks were determined to be insolvent while the subsidiaries continued being solvent, the subsidiaries would not have a shareholder with an ability to provide additional support when needed, and would be required to look for new shareholders with the required financial strength. Possible scenarios for solvent and profitable subsidiaries depend on the specifics of each subsidiary and financial system they operate in. Subsidiaries’ systemic importance, solvency and profitability would be key factors alongside their market features (e.g. extended branch network), leading to the following possibilities: • Sale to a local competitor(a bank or other financial institution). Although possible in some markets, competition constraints, where ownership is already concentrated, may preclude such sales. Also, many local banks may not have the financial and operational capacity to absorb a merger with a Greek owned subsidiary. • Sale to an incoming strategic investor. There has been limited activity in the past few years, mostly by Turkish or Russian banks (currently facing the deterring effect of sanctions). However, this option may be limited with multiple banks for sale and previous strategic investors reversing or having finished their expansion. • Sale to private equity or similar institutional investor. Although not common in the region, this type of investors can be local or foreign, and typically seeks fire sale prices (which may not be received positively by local authorities). Islamic sources of fund are a possible option in Albania, although the interest may be less in other countries. • Sale via a public offering. Markets in client countries are, however, too small to absorb anything but very small deals. (e.g. the loan book) and the rest sold and • Absorption of subsidiaries’ parts by other banks  liquidated. International financial institutions could play an important role in facilitating the sale of Greek subsidiaries. This could be in the form of performing appraisals, participating in financial solutions, and working on the consolidation and/or disposition of assets. 32  |  2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN Structural and Demographic Issues Structural issues must be tackled so that the Cyclical factors have clearly affected recent SEE6 countries can accelerate growth and growth dynamics, but there is a general concern restart their EU convergence process. From that the region’s transition to high-income 2000 to 2007, solid growth in the region moved status will be seriously delayed by adverse average income per capita (on a PPP basis) up demographic and structural factors. from 23 percent of the EU average to 31 percent (Figure 2.7). However, convergence decelerated While cyclical factors such as lower oil prices after 2008, with relative incomes remaining at and external recovery are expected to drive 31 to 32 percent between 2008 and 2013, the SEE6 outlook in the medium term, when real PPP per capita in the EU fell by addressing structural rigidities is crucial 2 percent (Figure 2.8). In addition, slow to unleashing SEE6 economic potential progress on structural reforms has held back and increasing living standards of the potential growth in SEE6. Sustained growth population. Addressing structural issues along has yet to revive in the SEE6, raising concerns five policy fronts to dismantle the key obstacles that the region is caught in a middle-income to potential growth in SEE6: trap. Figure 2.7: Income convergence of the SEE6 Figure 2.8: …as growth in the region has with the EU has slowed… stalled since the global financial crisis GDP per capita (international PPP) relative to EU, percent Growth in real GDP per capita (international PPP), percent; GDP per capita (international PPP) relative to EU, percent 45 8 7 40 6 5 35 4 30 3 2 25 1 0 20 -1 15 -2 0 1 2 3 4 5 6 7 8 9 0 1 2 3 200 200 200 200 200 200 200 200 200 200 201 201 201 201 22 24 26 28 30 32 34 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ SEE ▬▬ SEE 2008–2013 ▬▬ SEE 2001–2007 Sources: WDI, World Bank staff calculations. Source: WDI, World Bank staff calculations. Note: ECA is developing Europe and Central Asia. Note: ECA is developing Europe and Central Asia. Long-term income growth will be small in 1. Eliminate disincentives and barriers SEE6 unless countries in the region address to formal employment. Labor markets their structural and demographic challenges. across the region are anemic. They suffer 2. Policies for Income Growth and Competitiveness  |  33 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 from persistently high unemployment, 3. Enhance the equity and efficiency of low labor force participation, and sluggish public services and social protection formal job creation. Labor market systems, while reducing the outcomes are particularly weak among governments’ footprint. In most SEE6 some groups of the population such as countries, the public sector tends to be youth, Roma and women. Reducing large and inefficient, delivering public labor law rigidity would help to activate services that are too expensive. Addressing the most vulnerable groups on the mostly structural rigidities related to the dual labor markets in the region; the laws efficiency, size, equity and quality of public overprotect insiders and largely exclude service delivery while maintaining fiscal youths, females, and elderly from the sustainability is on the policy agenda. For labor force. Reform to education systems example, improving the delivery of health to better align them with skills the labor services is particularly important because market demands and remove disincentives it has potential spillovers to human capital and barriers to formal labor engagement and productivity of workers. At the same are shown to have meaningful impacts time, ensuring that vulnerable groups for growth. Increasing income-generating are effectively and efficiently protected opportunities in the labor market, will remain central to addressing issues including for the less well-off and excluded, of poverty and inclusion in the region. is critical to boost growth prospects and Efforts to reinforcing pension systems, increase living standards across SEE6. improving the targeting and coverage of social protection systems, modernizing 2. Improve the investment climate and benefits administration, and making governance. Even though some progress active labor market programs more has been made in easing the problems effective would have important social of the investment climate (e.g., in FYR impacts, while contributing to needed Macedonia and Montenegro), there is fiscal consolidation. still room for improvement. Applying the law in non-discretionary manner and 4. Deepen trade integration. Improving protecting rights to property (including the physical and institutional connectivity land) and contracts are central to ensure of the SEE6 within and across countries a level playing field. Regulatory reforms and the rest of the world would help that simplify legislation, promote make the region more competitive, e-governance, and establish one-stop supporting domestic and foreign firms in registration shops, are shown to reduce reaching beyond established markets and business costs and encourage private products. Advancing in the EU accession sector development in countries around process represents an opportunity for the world. Improving the governance of the SEE6 to pursue an EU integration SOEs and reducing their burden on the agenda that will have positive impact state is also a priority for policy reform in on potential growth through improved the SEE6. trade and export performance. For all 34  |  2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN SEE6 countries, strategically upgrading age people, bringing the total number of obsolete infrastructure would boost dependents to 8.1 per 10 working-age people. economic potential—provided such According to the UN population projections, investments target projects with positive not only is the composition of the population economic returns and do not threaten the expected to change but also its size, shrinking sustainability of public debt. by 25 percent by 2065. This demographic transformation may hurt economic growth 5. Ensure sustainable use of energy and as the working-age population of the region natural resources and stewardship of declines, all else remaining equal. Moreover, the environment. The energy sectors of in the face of aging populations and rising SEE6 economies are inefficient. Persistent fiscal costs of pensions and health care, weaker distribution losses, regulated tariffs that tax revenues is something many governments are below cost recovery, and low collection in SEE6 can ill afford and many countries rates lead to recurrent energy shortages continue to face fiscal pressures that could limit (especially, in economies that rely heavily the scope for fiscal policy interventions. In the on hydro generation) as well as either context of ageing societies, such developments high costs for the private sector or an represent a serious challenge to both persistent extra burden on public finances, or both. economic growth and the sustainability of Addressing these issues would make the public finances. However, it is possible to energy sectors financially viable, ensure mitigate these effects with comprehensive reliable energy supplies, and support policies focused on enhancing productivity economic growth. The SEE6 are endowed and behavioral adjustments by individuals and with natural beauty, cultural heritage, and firms toward flexible work in later age of life.13 resources that, used well, can boost long- term national growth potential. However, Creating employment and income generating SEE6 countries are also among those most opportunities provides incentives for young vulnerable to natural hazards and weather individuals to stay or return home from changes, which necessitate efforts to build abroad, attenuating not only the effects of resilience against them. aging, but also potentially increasing the quality and quantity of human capital in In the long term, income growth will be SEE6. In the last two decades, close to 5 million increasingly pressed by demographic factors people originating from SEE6 countries are including the aging and shrinking societies counted as migrants in another country; this is across the SEE6  (see Special Topic). The the equivalent of 25 percent of the source median person in the region is already 8.7 years population in SEE6.14 These migrants tend to older than the median person in the world. The be of working age, reducing the size of the labor difference will widen to a projected 11.7 years force in their home countries (see Box 1.2). The in the next 50 years. Today, there are on average 2.2 old-age dependents per 10 working-age people in the SEE6. By 2065, there will be a 13 This RER Special Topic paper on aging in SEE6 discusses these issues. projected 5.6 old-age dependents per 10 working 14 UN International Migrant Stock 2013 Revision. 2. Policies for Income Growth and Competitiveness  |  35 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 average migrant originating from SEE6 appear services. A comprehensive reform agenda to be better educated than its resident based on the pillars identified above that also counterpart. This is the case in particular for ensures macrofiscal stability would build SEE6 tertiary-educated Albanians and secondary- resilience against medium-term shocks. It will educated Serbians emigrants (Figure 2.9). also help countries move forward on the path These migrants have directly contributed to the to EU accession (see Box 2.4). economies of their “home” (Western Balkans) countries primarily through the remittances channel. But by moving abroad they have depleted the human capital stock of their countries. Slowing outmigration may not only partly increase the supply of working age people, but also in some cases may give a boost to skills in SEE6 Figure 2.9: Working age emigrants from Albania and Serbia tend to be better educated than their counterparts at home Education of emigrants and source country population, 2005 Albania Serbia 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0 Emigrants ALB Emigrants ALB Emigrants ALB 0 Emigrants ALB Emigrants ALB Emigrants ALB 15–24 25–64 65+ 15–24 25–64 65+ JJ Primary JJ Secondary JJ Tertiary JJ Unkown Source: World Bank staff computations based on the following datasets. Education of emigrants: OECD DIOC 2005/06 database; education of source country population: Barro and Lee (2013). In sum, there appear to be two requisites for sustained income growth at middle- income levels. The first is ensuring macrofiscal stability, so that any gains from growth are secure against being reversed by later crises. The second is addressing structural challenges, including related to demographic, that impede development, private sector competitiveness, and the efficiency and effectiveness of public 36  |  2. Policies for Income Growth and Competitiveness GROWTH RECOVERS, RISKS HEIGHTEN Box 2.4: EU Council Conclusions on SEE6 Economic Reform Programs The economic and structural priorities the EU has recommended to the SEE6 are directed to macroeconomic stability and structural reforms. In May 2015 the ECOFIN Council adopted the first comprehensive approach to the economic policy dialogue in EU candidate countries. Two sets of priorities were flagged for the SEE6: (1) strengthening the medium-term macrofiscal framework; and (2) enhancing competitiveness and long-term growth. Assessments of SEE6 countries found that reinforcing public finances, improving the efficiency of the financial sector, removing rigidities in product markets, and upgrading the educational system to better align with the needs of the private sector should be priorities throughout the region (Table B2.4.1). Table B2.4.1: Economic Reform Programs for SEE6, 2015 Public finances Financial Labor Product & service Education Social Admini- sector market markets inclusion stration Country Public Taxation Pension Banking Labor Services Innovation Education Poverty Adminis. finances system and access market and and and skills and social moderni- to finance network business inclusion zation & industries environm. rule of law ALB BIH MKD KOS MNE SRB Source: http://ec.europa.eu/europe2020/index_en.htm. Note: The EC recommendations for 2015–16 were presented on May 13, 2015. 2. Policies for Income Growth and Competitiveness  |  37 Spotlight: Poverty Trends and Expected Developments GROWTH RECOVERS, RISKS HEIGHTEN Poverty Trends higher dependency rates reduced the coping mechanisms available to them. For example, In SEE6 poverty reduction after 2008 has throughout the region, unemployment and been lackluster. Prior to the global crisis, inactivity were concentrated among individuals economic growth was strongly associated with few skills—the poor, the bottom 40 percent with poverty reduction throughout countries of the welfare distribution, and minorities like in the region. In the aftermath of the crisis, the Roma—and among young people. the pace of economic growth decelerated and the downward poverty trend that most SEE6 It is estimated that in most SEE6 countries countries had seen in the 2000s tapered off, and economic growth and poverty reduction are some of the gains eroded. Using the regional slowly returning. The fact that countries with poverty line of US$5/day PPP, it is estimated lower GDP growth in recent years are not yet that the poverty rate went back up in most consistently reducing poverty underscores the SEE6 countries. (Figure S.1). importance of rekindling economic growth and job creation. Figure S.1: Economic Growth and Poverty US$5/day PPP, 2000–13, Percent yy After major improvements in living 35 standards in Albania up to the 2008 30 global financial crisis, as economic growth 25 slowed between 2008 and 2012, poverty 20 reduction stagnated. Weak labor markets— 15 particularly rising unemployment—and 10 a reduction in remittances inflows have 5 limited the recovery in recent years. This 0 year growth is slowly accelerating, and as economic growth translates into job -5 1 2 3 4 5 6 7 8 9 0 1 2 3 creation, poverty is expected to have a slow 200 200 200 200 200 200 200 200 200 201 201 201 201 ▬▬ Poverty headcount $5/day ▬▬ GDP per capita growth downward trend. Source: The harmonized ECAPOV dataset and WDI. Note: Regional average excludes Kosovo due to difficulties in calculating PPP welfare aggregates. yy In Bosnia and Herzegovina, after a sluggish economic performance in 2014 Worsening labor markets—in a region with driven by the impact of the floods, the already persistently high unemployment economy seems to be gradually recovering, and low labor force participation—drove with GDP growth projected at 1.9 percent the declines in living standards across growth for 2015. The precrisis poverty most countries. Access to income-generating reduction trend, driven by economic opportunities for already disadvantaged groups growth, stalled. further narrowed. Limited access to assets, weaker engagement in the labor market, and yy In Kosovo, an exception to regional poverty reduction trends, consumption per This spotlight is based on the World Bank “Macro and Poverty Outlooks” of October 2015. capita grew by nearly 4 percent annually Spotlight: Poverty Trends and Expected Developments  |  41 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 for the bottom 40 percent from 2008 into recession in 2014, primarily because through 2011, compared to 2.4 percent of the floods, which pushed poverty up. for the top 60 percent; both poverty and With the recovery of economic growth in inequality thus receded. Although GDP early 2015, it is expected that poverty will growth decelerated to 1 percent in 2014, it again start to slowly decline. is expected to pick up to 3 percent for this year, which should help improve living standards. Labor Markets and Poverty yy In FYR Macedonia, national poverty Despite disproportionate reliance by estimates show poverty as having decreased international standards on non-labor since 2010. According to data from the income, labor is still the largest source of Survey of Income and Living Conditions income in SEE6 countries. Although labor (SILC) for 2010–13, the share of the income accounts for a majority of income in all population at risk of poverty declined countries but Serbia, its relative share is still from 27.0 percent in 2010 to 26.2 percent lower than in other middle-income regions like in 2012 and then to 24.2 percent in 2013. Latin America. Pension income comprises the Considering that the threshold for those second largest source of income in most SEE6 at risk of poverty went up between 2010 countries, particularly for better-off households. and 2013 by 6 percent in real terms, The share of social assistance in total household this result signals an improvement in income varies by country, but together with living conditions at the bottom of the pensions helps explain the relatively low distribution. reliance in labor market income in SEE6 (Figure S1.2). yy In Montenegro, the poverty rate, measured at US$5/day PPP, increased from an Sluggish labor markets have slowed average of 15.2 percent in 2005–2008 to progress in reducing poverty. Despite some 19.2 percent in 2012. It is estimated that recent improvements, labor markets are weak poverty reduction resumed with positive throughout SEE6. In Albania, an increase in GDP growth and employment expansion the unemployment rate from 13.7 percent in in 2014. Q2 2012 to 17.3 percent in Q2 2015 limited the impact on poverty of increased economic yy In Serbia, after substantial progress in growth in 2013 and 2014. Labor markets have reducing poverty in the mid-2000s, recently been picking up, however: employment since 2008 minimal growth and poor rates rose by about 2 percentage points between labor market outcomes have heightened Q2 2014 and Q2 2015, benefitting workers in both poverty and vulnerability: poverty all sectors. had risen from 10.6 percent in 2008 (US$5/day PPP) to 15.1 percent by  n Kosovo, labor markets are a major challenge. I 2010. Serbia’s economy, which has been Unemployment in 2014 is estimated to have struggling in recent years, moved back been 35 percent. Long-term unemployment 42  | Spotlight: Poverty Trends and Expected Developments GROWTH RECOVERS, RISKS HEIGHTEN Figure S1.2: Household Income by Source in L  abor market outcomes have improved slightly SEE6 in FYR Macedonia, but the unemployment Percent rate still averaged 28 percent in 2014, just 1.0 0.9 1 percentage point lower than in 2013, and 0.8 between 2013 and 2014 employment went 0.7 up from 40.6 to 41.2 percent of the working- 0.6 age population. The biggest contributors to 0.5 employment growth were the public sector 0.4 and information and communication, followed 0.3 0.2 by water supply and administrative services. 0.1 Manufacturing, construction and trade also 0 B40 T60 B40 T60 B40 T60 B40 T60 B40 T60 B40 T60 contributed to job creation, although in ALB BIH KOS MKD MNE SRB JJ Labor income JJ Pension JJ Social assistance relative terms their sectoral growth was modest. JJ Remittances JJ Other However, youth unemployment rose from 51.9 Source: World Bank. 2014. Southeast Europe “Regular Economic Report Special Topic: First Insights into Shared Prosperity.” to 53.1 percent in 2014, the third highest in Note: B40 refers to the bottom 40 percent and T60 to the top 60 percent the region after Bosnia and Herzegovina and of income distribution. Additional data are from the Montenegro 2013 HBS and from Serbia 2013 SILC. Kosovo. reached 69 percent of the unemployed, and  n the first half of 2015, the unemployment rate I youth unemployment exceeded 61 percent. in Montenegro was at 17.6 percent, its lowest Discouraged workers accounted for about level since 2008. The labor force participation 10.7 percent of the working-age population rate for people aged 15 and over went up to in 2014. The labor force participation rate 53.1 percent and employment to 43.8 percent, was 4 percentage points higher than in 2012 but are still low by international standards. but is still extremely low at 41.6 percent. The Gross wages were flat in 2014, however; growth employment rate increased from 25.6 percent in labor income was primarily driven by hiring. in 2012 to 28.4 percent in 2013, but fell again to 26.9 percent in 2014. I  n Serbia, labor market outcomes stumbled after the 2009 crisis, and unemployment I  n Bosnia and Herzegovina, the unemployment among those of working-age increased from rate in Q1 2015 was unchanged at 27.5 percent, 13.6 percent in 2008 to a peak of 23.9 percent compared to Q1 2014. Unemployment in 2012. As the Serbia economy moved out of among youth (15–24) was extremely high at recession in the second quarter of 2015, the 62 percent, according to 2015 LFS. Among unemployment rate in the second quarter was the unemployed, 82 percent have been seeking 17.9 percent, down from 20.3 percent a year employment for over 1 year. The total number earlier. Among young people, unemployment of the employed in the economy increased by is particularly high at 43.1 percent. With 1.7 percent for Q1 of 2015 with respect to Q1 public wages frozen, overall real wages fell in of 2014, but much of the increase originated early 2015. in public administration, while gross earnings remained constant during 2014–2015. Spotlight: Poverty Trends and Expected Developments  |  43 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Beyond labor income, pensions and of limited fiscal space, where it is difficult to public and private transfers made useful support large transfers, dysfunctional labor contributions to poverty trends in several market is a critical bottleneck to continued countries. In Albania, Bosnia and Herzegovina, progress in every SEE6. and Montenegro, pensions have been a key poverty-reducing factor, partially mitigating the I  n Albania, as the economy continues to impact of the economic downturn. As seen in gradually accelerate, further reductions in Figure S1.2, remittances have become especially poverty are expected in 2016 and 2017. significant in Kosovo, where an estimated 20 to However, a prolonged crisis in neighboring 25 percent of households (particularly among Greece may further adversely impact Albania’s the better-off) receive foreign remittances. growth and poverty prospects, through reduced Remittances have a large role in household remittances, exports, and investment. If these income in all SEE6 countries and have an risks materialize, labor markets and remittances important role in supporting growth and inflows could weaken and living standards of inclusiveness in SEE6. Austria, Germany, Italy, the population could be affected. and Greece are the main destinations for SEE6 migrants.  n Bosnia and Herzegovina, unemployment I is expected to remain high, particularly among youth. Constraints on hiring created in part by Poverty Outlook the high tax burden are expected to continue, while the substantial slack remaining in the As economic growth firms up in the medium labor market will contain real wages. The term, poverty is expected to go down in incidence of poverty (US$5/day PPP) is likely several countries; nevertheless, weaknesses in to fall only marginally in 2015–17. the labor market will continue to act against sustained poverty reduction throughout  n Kosovo, the national poverty rate is not I the SEE6. Progress in reducing poverty and expected to improve significantly during boosting shared prosperity will be particularly 2015–2017. Little progress is expected in difficult because of persistently high reducing high unemployment and poverty. unemployment, low labor force participation Unemployment remains high because the pace rates, and high degrees of informality. Only of job creation is expected to absorb only two- 32 percent of working age people in Bosnia and thirds of new job seekers. In the absence of Herzegovina are employed, and 56 percent are dynamic job creation, steady migration outflow out of the labor force. Bosnia and Herzegovina has helped release the pressure on the Kosovo and Kosovo have youth unemployment rates labor market. Moreover, low inflation and above 60 percent, with FYR Macedonia and positive and significant growth in agriculture Serbia not far behind. Globally, employment might accelerate growth in consumption by the has been shown to be the single most effective bottom 40 percent, as most live in rural areas. and durable mechanism for reducing poverty, but the SEE6 countries are still heavily reliant I  n FYR Macedonia, poverty is expected to on non-labor income. Especially in a context continue its decreasing trend in the next few 44  | Spotlight: Poverty Trends and Expected Developments GROWTH RECOVERS, RISKS HEIGHTEN years. The positive economic growth in 2014 reduction will be undermined if the economic and the expected positive rates for the 2015– recovery does not translate into jobs, and if the 2017 period should keep pushing poverty barriers and disincentives that confront people down, as employment continues to be created in trying to access jobs are not addressed. construction (propelled by public investment), manufacturing and export related industries. In an environment of slow and volatile Increases in social benefits are expected to growth, and limited fiscal space, boosting have contributed to further decreases in 2015, job opportunities for the population, and to keep playing an important role in the particularly the poor and vulnerable, is a upcoming years, although there are concerns critical challenge for all SEE6 countries. In about its fiscal sustainability. The agricultural addition, providing well-targeted social safety sector has had slow growth and has been nets is critical to ensure that shocks, like the volatile in recent years, hence making unlikely ones the region has suffered in recent years, a considerable reduction of rural poverty in the do not erode progress toward better living near term. standards. The need to boost job opportunities, alongside social protection, is even greater  n Montenegro, positive economic growth is I for countries undergoing fiscal consolidation expected to reduce poverty further via higher reforms like Serbia. employment (largely in construction and tourism) and wages and a deceleration of private sector deleveraging. However, the labor market is exposed to volatile regional economic developments, and household welfare remains highly vulnerable to macro risks.  e poverty outlook for Serbia mirrors the Th vulnerability of the macro-fiscal outlook. Poverty is expected to slowly decline with returning economic growth, some improvements in labor demand and employment expansion. However, poverty reduction remains highly fragile due to still weak labor markets and the potential impact of the structural reform measures that have been announced. In addition to the adverse impacts of the global economic crisis and the economic and weather shocks that followed, unaddressed structural issues will continue to hinder prospects for poverty reduction and shared prosperity. Especially, sustained poverty Spotlight: Poverty Trends and Expected Developments  |  45 SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN Albania Albania’s economy continued to expand in the first half of 2015, albeit remaining below potential. Growth was driven primarily by investment and net exports, while private consumption continued to suffer, reflecting sluggish consumer confidence. Private investments have benefited from improvements in business climate and the repayment of a large stock of government arrears to the private sector, and are expected to continue strong in the near term. In contrast, public investment, which has expanded so far, could be affected by fiscal consolidation efforts, in the absence of other adjustments. Real GDP growth is expected to reach 2.7 percent in 2015, up from 2.1 in 2014. Main downside risks to economic growth include high NPLs that limit credit growth, low oil prices and subdued external demand. Albania’s economy continues to grow in Real GDP, annual growth rates and Economic 2015 on account of stronger domestic Sentiment Indicator investments. Real growth reached 2.8 percent Index (2010Q1=100) In percent 6 120 year-on-year in the first quarter of 2015. 5 Growth has been mainly driven by investment 100 4 and net exports, which compensated for a 3 80 contraction in private consumption. Available 2 60 high frequency data suggest a similar pattern in 1 the second quarter of the year, although with 0 40 slightly lower growth rate due to the impact of -1 20 the Greece crisis on remittances, exports and -2 credit. Our latest projections see a downward -3 0 12 12 13 13 14 14 15 Q1- Q3- Q1- Q3- Q1- Q3- Q1- revision of growth in 2015 to 2.7 percent from JJ Real GDP ▬▬ Economic sentiment indicator, rhs 3 percent we projected earlier in the year. Source: Bank of Albania, INSTAT. Improvements in business confidence and the steady increase in capacity utilization rates lower oil prices, contributing to the reduction suggest that private investment, mainly FDI in the nominal trade deficit. While the value driven, will be a key contributor to GDP of imports decreased on annual terms, imports growth. of machinery and equipment remained strong, suggesting a pickup in investment. FDI The merchandise trade deficit narrowed increased significantly during the first quarter as a result of both increasing exports and of 2015 by around 53 percent year-on-year decreasing imports. Exports continued to after falling in the last quarter of 2014, driven increase for the second quarter in a row despite by FDI to the drilling sector. Additionally, net SEE6 Country Notes  |  49 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 inflows in the financial account increased by increased by 10.6 percent compared to the 26.5 percent annually, contributing positively same quarter of 2014. Employment has to the financing of the current account deficit. increased in previously declining sectors These positive results happened despite the such as construction, non-market services, declining export income, remittances, and FDI manufacturing and activities of market services. inflows from Greece. The unemployment rate reached 17.3 percent in the second quarter of 2015, which is Average inflation remained below the target lower compared to the same quarter of 2014 band of 2–4 percent, reflecting deflationary (18.6 percent). Participation rate has marginally pressures from abroad and depressed decreased in the first quarter 2015 reaching domestic consumption. Inflation followed 63 percent from 63.6 percent in last quarter of a positive trend during the first months of 2014, however has increased compared to the 2015, driven by supply-side shocks (floods first quarter of last year (57.9 percent). in January and February 2015) and price volatility of specific goods (i.e. unprocessed Fiscal Revenues, Expenditures, and Overall food prices). However, starting from May Balance 2015, the low import prices pushed inflation In percent of GDP 35 0 down below the targeted range, reaching 1.3 percent in July 2015. The Central Bank 30 -1 maintained a lax monetary policy stance, by 25 -2 keeping the policy interest rate unchanged at 20 -3 a historic minimum of 2 percent. The lower 15 -4 policy rate translated into lower credit interest 10 -5 rates, which contributed to the increase in lek lending (7.5 percent on annual terms). The 5 -6 developments in Greece over the summer 0 -7 prompted the Central Bank to step up efforts 2009 2010 2011 2012 2013 2014 2015 2016 2017 JJ Overall balance, rhs ▬▬ Total revenues & grants ▬▬ Expenditures to further safeguard the financial system, lower Source: Ministry of Finance, WB staff calculations. financing costs and address NPLs. Coupled with the regulatory measures already started at the beginning of the year, these efforts reduced Fiscal consolidation is falling on the the NPLs from 22.4 percent of gross loans at expenditure side. During the first half of 2015 the end of 2014 to 20.9 percent by the second expenditures shrank by 0.9 percent year-on- quarter of 2015. However, NPLs remain still year to 195.6 billion Lek. In contrast, capital high reflecting sizable default risk, and with expenditure rose by 5.4 percent relative to weak credit demand and conservative lending the same period of 2014, which reinforce the practices suppress the credit recovery. positive contribution of investment to GDP in the first quarter of 2015. Labor market indicators suggest a modest, but positive employment growth during On the revenue side, consolidation efforts the second quarter of 2015. Employment were less effective than on the expenditure 50  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN side due to poor revenue collection, as from 2.1 percent in 2014 to 2.7 percent in well as lower than expected inflation and 2015, 3.4 percent in 2016 and 3.5 in 2017 oil prices. This dynamic already noticed in supported largely by an increase in investment. the budget indicators for the first quarter, Additionally, private consumption is expected continued to be present during the second to gain strength, increasing its contribution quarter as well. By June 2015, tax revenue grew to growth. This projection assumes the by 4.4 percent from a earlier year (instead of realization of the structural reforms in energy, 9.4 percent expected), or 8.6 billion Lek shorter financial management of public investment than originally forecasted. While revenues and pensions. Expected improvements in the from the “small business tax” and profit tax business climate and investor confidence and increased by 22.5 percent and 21.7 percent, strong FDI inflows are likely to positively respectively, other taxes underperformed in affect economic activity. Lower financing cost the first half of 2015. The “custom duties” and comprehensive efforts to lower NPLs and “national tax and others” revenues shrank are expected to strengthen credit, private by 4.1 percent and 3.0 percent on annual consumption and investment. Fiscal deficit is terms, respectively, during the same period. projected to decline from 5.1 percent of GDP Although revenues underperformed mainly in 2015 to 2.3 percent of GDP in 2016 due due to tax administration bottlenecks, their to further fiscal consolidation efforts on both dynamics is somehow consistent with an expenditure and revenue sides, and despite the investment-driven domestic demand and continued clearance of arrears. On the external sluggish consumption. The fiscal deficit is front, higher imports of investment goods likely to reach 5.1 percent in 2015 given the are likely, while export growth continues to continuation of the government to clear off moderate in dollar terms as a result of subdued the arrears in the upcoming months. The fiscal oil prices. deficit will be funded largely by external funds, including of IFIs, while the share of domestic financing is decreasing. Public debt is projected to marginally increase to 73.2 percent of GDP in 2015 from 72.5 percent of GDP in 2014. It still remain at elevated levels and subject to the fiscal consolidation and refinancing risk. Persistent fiscal adjustments are expected to put debt to a downward trajectory to 57.1 percent of GDP by 2019. Outlook Growth is expected to increase gradually over the medium term to reduce the output gap. Real GDP growth is projected to rise SEE6 Country Notes  |  51 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Sectoral contributions to GVA growth Monetary aggregates (production side) In percent In yearly terms change in percent 6 35 4 30 25 2 20 0 15 -2 10 5 -4 0 -6 -5 12 12 13 13 14 14 15 9 0 1 2 3 4 5 Q1- Q3- Q1- Q3- Q1- Q3- Q1- r-0 r-1 r-1 r-1 r-1 r-1 r-1 Ma Ma Ma Ma Ma Ma Ma JJ Agriculture JJ Extractive industry JJ Manufacturing ▬▬ Broad money growth ▬▬ NPL ratio JJ Construction JJ Trade, hotels and restaurants, transport ▬▬ Credit growth JJ Communications JJ Other services Source: INSTAT, WB staff calculations. Source: Bank of Albania, WB staff calculations. Confidence Survey indicators Headline inflation Differences of balances In yearly terms change in percent 20 5 10 4 0 3 -10 2 -20 -30 1 -40 0 10 3-10 1-11 3-11 1-12 3-12 1-13 3-13 1-14 3-14 1-15 -08 -09 -10 -11 -12 -13 -14 -15 Q1- Q Q Q Q Q Q Q Q Q Q Aug Aug Aug Aug Aug Aug Aug Aug ▬▬ Trade ▬▬ Consumption ▬▬ Services ▬▬ Industry ▬▬ Construction Source: Bank of Albania. Source: INSTAT. Unemployment and Employment Public Debt In percent In percent of GDP 70 80 60 70 50 60 40 50 40 30 30 20 20 10 10 0 0 12 12 13 13 14 14 15 Q1- Q3- Q1- Q3- Q1- Q3- Q1- 2010 2011 2012 2013 2014 2015 2016 2017 ▬▬ Employment ▬▬ Unemployment ▬▬ Total PPG debt Source: INSTAT, WB staff calculations. Source: Ministry of Finance, WB staff calculations. CAD, FDI and other investments In millions of Euro 400 300 200 100 0 -100 -200 -300 -400 13 13 13 13 14 14 14 14 15 15 Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- JJ Current account JJ Direct investments JJ Other investments Source: Bank of Albania 52  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN ALBANIA 2012 2013 2014 2015f Real GDP growth (percent) 1.6 1.1 2.1 2.7 Composition (percentage points): Consumption 0.3 1.2 3.7 -0.6 Investment -2.3 -0.8 0.2 2.0 Net exports 3.7 0.7 -1.7 1.2 Exports -0.3 3.5 -6.1 -0.6 Imports (-) 4.0 -2.8 4.4 1.8 Consumer price inflation (percent, period average) 2.0 1.9 1.6 2.1 Public revenues (percent of GDP) 24.7 23.7 26.2 27.0 Public expenditures (percent of GDP) 28.2 28.9 32.0 32.1 Of which: Wage bill (percent of GDP) 5.2 5.2 5.1 5.1 Social benefits (percent of GDP) 10.5 11.1 11.7 11.3 Capital expenditures (percent of GDP) 4.6 4.8 4.3 4.4 Fiscal balance (percent of GDP) -3.5 -5.2 -5.8 -5.1 Primary fiscal balance (percent of GDP) -0.3 -1.7 -2.4 -0.6 Public debt (percent of GDP) 58.0 66.3 68.4 68.5 Public and publicly guaranteed debt (percent of GDP) 62.0 70.1 72.5 73.2 Of which: External (percent of GDP) 26.8 26.6 29.2 32.9 Goods exports (percent of GDP) 15.9 18.1 9.2 8.2 Goods imports (percent of GDP) 36.8 35.7 30.6 29.8 Net services exports (percent of GDP) 2.2 -0.2 2.7 2.7 Trade balance (percent of GDP) -18.7 -17.9 -18.7 -18.9 Remittance inflows (percent of GDP) 9.2 7.0 7.2 6.8 Current account balance (percent of GDP) -10.2 -10.7 -13.0 -13.1 Foreign direct investment inflows (percent of GDP) 6.8 9.5 8.0 8.2 External debt (percent of GDP) 35.6 34.3 36.7 42.3 Real private credit growth (percent, period average) 4.6 -3.5 -1.4 0.6 Non-performing loans (percent of gross loans, end of period) 24.0 24.1 22.4 20.9 Unemployment rate (percent, period average) 13.4 16.0 17.5 17.1 Youth unemployment rate (percent, period average) 26.1 27.2 32.5 33.6 Labor force participation rate (percent, period average) 57.3 52.4 53.7 55.1 GDP per capita, PPP (current international $) 10,123.2 10,363.5 10,736.5 11,334.5 Sources: Country authorities, World Bank estimates and projections. Notes: Labor market indicators and credit growth for 2015 reflect year-to-date annual rolling averages. Non-performing loans show year-to-date actuals. Youth unemployment rate is for labor force aged 15–29. SEE6 Country Notes  |  53 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Bosnia and Herzegovina Economic activity improved in the first half of 2015. The economy continues its recovery from the impact of the 2014 floods with indirect revenue collection, industrial production and the net trade balance all showing positive trends. Growth for 2015 as a whole is expected to reach 1.9 percent, up from 1.2 percent in 2014. A joint agreement between the national and sub-national authorities on the priority reform agenda for Bosnia and Herzegovina (BH) was signed in July 2015 and implementation of such reforms is key to an improved medium- term outlook. The agenda includes long-awaited labor reforms, on which there is some positive momentum with the recently adopted Labor Law in the Federation of BH (FBH). However, the quality and pace of implementation of the agreed reforms will depend crucially on political dynamics. Recent developments Consumption appears to have slightly improved in the first half of 2015, as seen The first half of 2015 saw an acceleration in growing imports of consumer goods, of economic activity, continuing the supported by increased bank credit to recovery from the impact of the 2014 floods. households. Investment, however, remains Improvements were seen in indirect revenue unchanged. Imports of capital goods grew collection, industrial production and the net by only 1.2 percent y/y in H1 2015, while trade balance. The official estimates show real long-term bank credit to private enterprises GDP growth of 2.1 percent in Q1 2015. The has experienced negative growth through the growth was mainly driven by construction entire period since February, contracting by and services. After exhibiting negative growth 0.9 percent y/y in June. for almost a year industrial production recorded positive growth in July reaching Improved indirect tax revenue performance 2.4 percent growth year-on-year (y/y). Energy in 2015 to date may reflect both the pick-up output, which was particularly affected by the in activity, as well as improved cooperation devastating floods of May 2014, seems to have among domestic tax agencies. In June the recovered faster than that of agriculture, which gross collection of indirect tax revenues (ITA) was also hit hard. Energy output grew in Q1 increased by 8.3 percent y/y, on the back of after four consecutive negative quarters. This higher VAT and excise tax collections, which year’s summer drought is adding to an already contributed 3.8 and 4.8 percentage points difficult situation in agriculture and hence the respectively to overall ITA revenue growth. recovery in activity in rural areas will take some Excise tax collection rose by 9.5 percent and time. VAT by 2 percent, with the former mainly driven by the excise tax on tobacco products 54  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN (accounting for 62 percent of excise taxes alcohol and tobacco, as well as of education, in June) and on petroleum (29 percent). health, housing and water rose in June. This progress was mainly due to expanded cooperation between four tax agencies on The currency board continues to support the exchange of taxpayer information. The monetary policy. International reserves authorities have also harmonized excises on remained at a comfortable level in H1 2015, different tobacco products in recent years. at around 6 months of imports. The euro- pegged convertible mark (BAM) appreciated Although growth is improving, slightly against the US dollar over the quarter, unemployment remains high and little down 1.5 percent in July relative to March, but changed given slow progress in advancing remains 12 percent weaker than in December economic reforms in 2014. While some 2014 following the marked depreciation earlier improvements in the employment numbers in 2015. Including the currency’s movements were recorded in Q1 2015, much of the increase against other trading partners, the nominal originated in areas of public administration. effective exchange rate (NEER) was unchanged Gross earnings also remained constant during in July relative to March, 2 percent weaker 2014–2015. However, signs of progress on than in December 2014. However, BH’s much-needed labor reforms have been seen. The relatively low inflation contributed to a further new labor code, which includes amendments weakening of the real effective exchange rate, to, for example, collective agreement and which as of July had fallen by 4 percent relative termination provisions, was adopted in the to December 2014, supporting the relative Federation of FBH (FBH) at the end of price competitiveness of the domestic economy. July while in the Republika Srpska (RS) the government has started consultations on the The Fiscal Council came to an agreement new labor code, including with trade unions. on the fiscal framework for 2016–2018 at If implementation of the new labor legislation the end of June 2015. This came after the is done promptly some improvements to delayed adoption of the 2015 budget by the unemployment rates should be expected in a BH institutions, following the protracted year from now. time for government formation in FBH and BH Institutions, the fiscal deficit is estimated Imported deflationary pressures further to reach 1.9 of GDP in 2015 on the back pushed down consumer prices. Deflation of improved revenue collection and some moderated in the first half of 2015 but slowdown in expenditures. In July 2015 the remained negative with consumer prices falling central bank published consolidated fiscal by 0.5 percent y/y in the first half of 2015, accounts data for 2014 indicating a deficit of down from a contraction of 1.5 percent a year 2.1 percent of GDP. This was little changed earlier. The biggest drivers of the fall came from the 2013 deficit (down by 0.1 percentage from the price of imported goods, for example, points of GDP due to faster growth in revenues for transport, reflecting weak oil prices, food, than expenditures). clothing and footwear. In contrast, prices of SEE6 Country Notes  |  55 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 The current account deficit narrowed in the 16.2 percent at end-March 2015 remains first quarter of 2015. The current account above the prescribed level of 12 percent and deficit declined to BAM 387 million in Q1 central bank stress tests show an adequate level 2015, versus BAM 478 million in Q1 2014. of capitalization. However, if the situation On a rolling four-quarter basis the current deteriorates further, some banks could need account deficit in Q1 was 7.2 percent of GDP additional capital. (down from 7.5 percent for 2014 as a whole). The narrowing of the current account deficit Selected Financial Soundness Indicators primarily reflected a decline in the trade deficit In percent as goods exports rose by 8 percent y/y against 20 a 1 percent contraction in imports. Data for 15 the second quarter indicating a continuation 10 of this trend with export growth, although at 5.5 percent down slightly on Q1, continuing 5 to outstrip that of imports (2.1 percent). 0 Exports are expected to further improve in the second half of the year, supported by the -5 recovery in the euro area, as well as support to -10 competitiveness from the real exchange rate 09 09 10 10 11 11 12 12 13 13 14 14 15 Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- and, over the longer-term, from reforms in JJ Capital adequacy (tier 1 capital to risk weighted assets) ▬▬ Asset quality (NPLs to total loans) ▬▬ Profitability (return on equity) the area of business competitiveness and labor Source: Central Bank of BiH. market. Worker remittances continued to be strong, supporting private consumption. In terms of the financing of the current account deficit, net FDI flows were weaker than a year Outlook earlier and covered about 22 percent of the quarter’s current account deficit. The remaining Growth is projected to strengthen to financing was from capital account inflows and 2 percent in 2015 and to rise moderately other investments (mainly new loans). in the medium term. In the near term, this is likely to be mainly due to the recovery Concerns over asset quality in the banking in external demand and the stepping up in sector remain. The share of nonperforming reconstruction efforts after the 2014 floods. loans in commercial banks’ portfolios was Enhanced progress on the implementation 14.2 percent at end-March 2015, up from of long-standing reforms will be required for 14.0 percent at end-December 2014. Banks’ the medium-term growth outlook to improve profitability also deteriorated in the first relative to this baseline. Other potential risks to quarter, partly due to high provisioning. Asset the outlook include possible delays in Europe’s quality is becoming an important obstacle for overall economic recovery that would have an reestablishing bank profitability mainly owing impact on exports, remittances and capital to poor corporate resolution and insolvency flows. frameworks. The capital adequacy ratio of 56  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN The challenge for fiscal policy will be to secure medium-term sustainability while supporting the still-needed recovery in growth. Fiscal consolidation will need to be gradually introduced in order to absorb the shock caused by the floods. The sustainability of public debt needs to be closely monitored as its scope, size and complexity has increased. In addition, particular focus will be needed on documentation of the arrears, full accounting of which does not exist. A related, persistent challenge is the high cost of employment, given the high tax wedge on labor. Reforming the labor market and improving the delivery of social protection delivery will also need to stay in the government’s focus while making sure that macro stability remains preserved. SEE6 Country Notes  |  57 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Real GDP growth Agriculture, manufacturing and energy Percent change, year-on-year Percent change, year-on-year, GDP production side 4 3 3 2 2 1 1 0 -1 0 -2 -1 -3 -4 -2 09 09 10 10 11 11 12 12 13 13 14 14 15 Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- 2012 2013 2014 2015f JJ Agriculture JJ Industry JJ Services ▬▬ Real GDP growth Source: BH Agency for Statistics. Source: BH Agency for Statistics. Consumer prices VAT Percent change, year-on-year Percent change, nominal, year-on-year 5 20 4 15 3 10 2 5 1 0 0 -5 -1 -10 -2 -15 -11 -12 -13 -14 -15 -13 pr-13 Jul-13 ct-13 an-14 pr-14 Jul-14 ct-14 an-15 pr-15 Jan Jan Jan Jan Jan Jan A O J A O J A ▬▬ Headline inflation ▬▬ VAT (y/y change) ▬▬ VAT (12 mma y/y change) Source: BH Agency for Statistics. Source: BH Indirect Taxation Authority. General government fiscal balance Exports and imports In percent of GDP Percent change, nominal 3 month moving average, year-on-year 0 40 -1 30 20 -2 10 -3 0 -4 -10 -5 -20 -11 Jul-11 an-12 Jul-12 an-13 Jul-13 an-14 Jul-14 an-15 Jul-15 2009 2010 2011 2012 2013 2014 2015f Jan J J J J ▬▬ Exports ▬▬ Imports Source: Fiscal authorities, WB Staff est. Source: BH Agency for Statistics, WB Staff calculations. Note: f=forecast. Real and nominal effective exchange rate index Share of foreign-currency indexed loans in total loans 2005=100; ‘+‘ denotes appreciation In percent of total loans 110 72 70 105 68 66 64 100 62 60 95 58 56 90 54 09 09 10 10 11 11 12 12 13 13 14 14 15 -08 -09 ec-10 -11 -12 -13 -14 -15 Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Dec Dec D Dec Dec Dec Dec Jun ▬▬ NEER ▬▬ REER JJ EUR JJ CHF Source: Central Bank of BH, WB Staff calculations. Source: Central Bank of BH, WB Staff calculations. 58  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN BOSNIA AND HERZEGOVINA 2012 2013 2014 2015f Real GDP growth (percent) -1.2 2.5 0.8 1.9 Composition (percentage points) Consumption 1.1 1.5 Investment 0.5 0.7 Net exports -0.7 -0.2 Exports -0.5 0.7 Imports (-) -0.2 -0.9 Consumer price inflation (percent, period average) 2.0 -0.1 -0.9 0.5 Public revenues (percent of GDP) 44.5 43.4 44.4 43.9 Public expenditures (percent of GDP) 46.6 45.6 46.4 45.8 Of which: Wage bill (percent of GDP) 12.9 12.5 12.1 11.9 Social benefits (percent of GDP) 17.1 16.8 17.3 17.0 Capital expenditures (percent of GDP) 3.2 4.0 4.3 4.5 Fiscal balance (percent of GDP) -2.0 -2.2 -2.1 -1.9 Primary fiscal balance (percent of GDP) -1.5 -1.7 -1.5 -1.3 Public debt (percent of GDP) 38.8 37.2 38.7 42.1 Public and publicly guaranteed debt (percent of GDP) 43.6 41.6 42.7 46.1 Of which: External (percent of GDP) 27.8 28.1 30.5 33.0 Goods exports (percent of GDP) 22.6 24.3 24.6 25.1 Goods imports (percent of GDP) 53.5 52.0 54.6 51.8 Net services exports (percent of GDP) 7.0 6.8 6.8 6.7 Trade balance (percent of GDP) -24.0 -20.8 -23.3 -20.0 Remittance inflows (percent of GDP) 8.1 8.1 8.4 8.6 Current account balance (percent of GDP) -8.8 -5.7 -7.7 -7.9 Foreign direct investment inflows (percent of GDP) -2.0 -1.7 -3.1 -3.1 External debt (percent of GDP) 52.2 50.8 54.6 54.2 Real private credit growth (percent, period average) 1.0 1.9 4.0 2.1 Non-performing loans (percent of gross loans, end of period) 13.5 15.1 14.2 14.1 Unemployment rate (percent, period average) 28.1 27.4 27.5 27.7 Youth unemployment rate (percent, period average) 63.3 58.8 62.9 62.3 Labor force participation rate (percent, period average) 44.0 43.6 43.7 44.1 GDP per capita, PPP (current international $) 9,214.0 9,562.8 9,808.0 10,359.6 Sources: Country authorities, World Bank estimates and projections. Notes: Real GDP growth data are based on production approach, which differ from estimates and projections based on expenditure approach. Historical data are not available for the latter. Labor market data for 2015 are preliminary. Credit growth for 2015 reflect year-to-date annual rolling averages. Non-performing loans show year-to-date actuals. SEE6 Country Notes  |  59 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Kosovo Although estimated real economic growth in the first quarter of 2015 was a very low 0.2 percent, it is expected to reach 3 percent for the year as a whole, fueled by consumption, exports of goods and services, and investments, both public and private. Foreign direct investment was promising in the first half of 2015, with more investment originating in the EU, and is expected to accelerate now that Kosovo and Serbia signed some initial political agreements in August 2015. Despite solid revenue growth in the first half of the year, fiscal consolidation is underway, rectifying the original 2015 budget revenue plans that had been based on the previous budget’s baseline and on optimistic projections, resulting in considerable revenue shortfalls. Without fiscal adjustment in 2015, it would have been difficult to honor the fiscal rule capping budget deficits, with few exceptions, at 2 percent of GDP . The IMF approved a 22-month, €184-million Stand-by Arrangement on July 29th, 2015. Recent developments a cut in public spending on goods and services and moderation in the growth of government This year the economy is showing signs of consumption to 0.3 percent, mainly due to the broad-based recovery, mainly driven by price deflator. That negative price effect will domestic demand and lower negative net disappear starting in Q2 2015, and public exports. The latest data from the Kosovo consumption is estimated to have made a solid Agency of Statistics estimated that economic growth in Q1 2015 was only 0.2 percent, the Real GDP Annual Growth Rates, Kosovo, result of 2.3 percent growth in private 2008–15 consumption, a drop of 1.5 percent in Percent change 5 government consumption, investments that 4.5 4.4 were lower by 0.6 percent, and a zero 4 3.6 contribution from net exports. On the 3.3 3.4 3.0 production side, agriculture and food processing 3 2.8 are growing at rates significantly higher than 2 the economy as a whole. However, even though Q2 growth numbers have not yet been released, 1 1.0 we project that a stronger pick-up of private consumption and investments will be driving 0 2008 2009 2010 2011 2012 2013 2014e 2015f higher economic growth for the remainder of Source: Statistics Agency of Kosovo, and World Bank staff projections. the year. The 25 percent increase in public Note: 2014 growth is a very preliminary estimate based on preliminary quarterly data while 2015 is WB projection. wages since March 2014 was partially offset by 60  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN contribution to growth in the first half of the construction of the highway to FYR Macedonia year. Workers’ remittances continued strong, had increased imports of investment goods rising by 18.7 percent y-o-y in the first half of (machinery imports went up by 7.8 percent 2015. Combined with higher wages and and means of transport more than tripled, pensions they will support the growth of private y-o-y) as well as transport services (which rose consumption. Growth in private investment, 86 percent, y-o-y). More Kosovars traveled boosted by more FDI and greater access to abroad, raising imports of travel services by mortgage loans (albeit from a very narrow 14.4 percent and telecommunication services base), is compensating for low public by 129.7 percent by June (y-o-y). Total exports investment. Although exports of goods are of goods and services rose by 11.3 percent by growing more than imports (14.5 percent vs. June (y-o-y), largely because exports of travel 5.1 percent), net export of goods was flat in the services grew by 19.6 percent and of base metals first half (y-o-y) because of a larger import base. by 39.2 percent. However, in services faster growth in imports than exports (30 percent vs. 8.5 percent) meant Financial account balances went up by that the contribution of net exports to growth 94 percent, with inflows of FDI showing was negative by the end of May. The net export signs of solid recovery so far in 2015. The of services normally shifts in favor of exports failed telecom privatization, a weak business during the summer when numerous members environment, and domestic political turbulence of the diaspora return to visit, as they have been in 2014 were among the factors that had caused doing this year. a substantial decline of net FDI in 2014; it reached only 2.8 percent of GDP, compared to Kosovo’s demographics—the average age of 4.7 percent in 2013. FDI in the construction the population is 26 years—create both labor sector may have also declined due to policies market and social pressures. Combined with imposed in 2014 by the new mayor of the capital feeble growth, this has led to social protests and city of Prishtina, to halt construction. Net FDI reportedly high emigrations to the EU at the inflow through June 2015 is estimated to have beginning of the year. The labor force data show grown by 3.1 times (y-o-y) and reached about that the unemployment rate went up in 2014 6 percent of GDP; most FDI originates in the by 5 percentage points, to 35 percent; Kosovo’s EU. This is a very important development: FDI unemployment, which is worse among the from the EU had declined to just 7 percent of youth and females, continues to be the highest the euro amount in 2007; it suggests that the in SEE6. trend is reversing. In 2015 real estate, rentals, and business activities continued to attract the External imbalances widened in the first bulk of FDI. Portfolio investments also grew by half of 2015. Higher investment- and 3 percent. consumption-related imports of goods and services (telecom, transport, and travel services) By June 30, 2015, under-execution of the and more outflows than inflows of primary capital budget (traditionally the fiscal buffer) income helped to push up the current account had produced a temporary fiscal deficit of deficit by 16 percent by June 2015. At that point 1.3 percent of GDP. Revenues had gone up by SEE6 Country Notes  |  61 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 7 percent due to more economic activity, more to businesses (6.2 percent). About two-thirds of imports, and the intensified efforts of the tax credit still goes to businesses and one-third to collection authorities. However, revenues still households; corporate consumption loans went underperformed by 5.5 percent due to earlier up by 16.5 percent, faster than the growth of over-optimistic revenue plans: By June 30, investment loans at 12.1 percent. Household Customs had collected only 42 percent of what mortgage loans went up by 41.8 percent, had been budgeted and the Tax Administration fueling investments in housing; household just 38 percent. Public expenditures had grown consumption loans grew just 6.7 percent. by 5.8 percent. Although revenues were less than expected, the temporary fiscal deficit Nonperforming loans (NPLs) are declining. was only 1.3 percent of GDP in June because They fell to 7.2 percent of total loans in capital spending had been only 24 percent of June 2015 from their peak of 8.8 percent in the budget for the year. Capital spending is February 2014, and the trend is in the right expected to rise quickly as bills for construction direction: NPLs are lower in Kosovo than in the of the highway and other roads come due after other SEE6 countries. The improvement came construction accelerated during the summer. because corporate NPLs went down, mainly due to successful activity of the new established An average y-o-y deflation of 0.5 percent private enforcement agents. Meanwhile, was recorded between December 2014 and household NPLs went up slightly. July 2015. The consumer price index turned to a negative 0.4 percent in December and remained flat through 2015, because prices Outlook for transportation fuel declined in the second half of 2014. Prices for higher education, Economic growth is expected to increase and accommodation services also plunged. from 3 percent in 2015 to 3.5 percent in Transportation annual price effects will carry 2016 and 3.7 percent in 2017, supported into November, but the education price effect by political stability (following political should disappear by September. impasse in 2014), larger FDI, consumption growth and rising exports. In 2015 we The financial sector continued to be assume no interruptions on energy production profitable and credit grew at an annual rate of (unlike explosion in Kosovo A power plant 7.1 percent from January through July 2015. in June 2014) and no large price deflation of Commercial bank profits increased by 67 percent consumption caused by public wage increase y-o-y in the first seven months of 2015, driven (April 2014). Consumption, fueled by by large cuts in expenditures. Interest rate remittances; investments, especially FDI; and spreads narrowed by an average 2.8 percentage exports of goods and services are all expected points to 7.3 percent as lending interest rates to support growth in 2015 and beyond. The fell. Improving supply and demand conditions negative effect that public wage increases have reflected on private credit, which increased by had on prices since March 2014 will start to 7.1 percent (y-o-y), driven by faster growth in disappear in Q2 2015 and public consumption credit to households (10.9 percent, y-o-y) than is expected to stimulate growth. Also, the 62  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN government has announced an economic on commodities with environmental and/ program to improve the business environment or health-related externalities, both effective and foster growth based on tax policy changes September 1, 2015, and also raise fees for sale effective in September and other structural of telecom operating licenses. changes to encourage new investments. The Republic of Kosovo and the Republic of Serbia have recently signed agreements that are a significant step toward resolution of their political conflict. That is expected to further improve Kosovo’s image of stability and attract even higher FDI from the EU; up to now all interested foreign investors, especially those from the EU, had perceived the political risk as relatively high. The new standby agreement (SBA) with the IMF is designed to support fiscal consolidation and macroeconomic stability while giving Kosovo fiscal space for growth, supported by other international financial institutions (IFIs), to boost capital spending. The IMF board approved a 22-month SBA for €184 million on July 29, 2015. Fiscal policies will be directed to keeping average deficits over the course of the program within the fiscal rule ceiling of 2 percent of GDP. This will keep public debt sustainable at well below 30 percent of GDP. It will also permit more productive capital investments beyond the 2 percent ceiling, allowing for IFI-supported public investments that amount to as much as 1.9 percent of GDP annually. The fiscal consolidation measures are expected to yield savings by containing the impact of last year’s pre-electoral decisions: they will keep public wages at their current nominal value, contain spending on goods and services, and delay execution of new schemes. Also, revenue-boosting measures inaugurated in 2015 will raise the main VAT rate from 16 to 18 percent (while introducing a lower rate on specific goods) and increase excise taxes SEE6 Country Notes  |  63 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Growth in Aggregate Demand, 2011–14 Growth in the Economy by Sector, 2010–14 In percent In percent 4.4 8 5 2.8 3.4 6 4.4 4 1.0 4 2.8 3.4 3 2 1.0 2 0 -2 1 -4 0 -6 -1 2011 2012 2013 2014 2010 2011 2012 2013 JJ Consumption JJ Investments JJ Net exports ▬▬ Growth JJ Agriculture JJ Industry JJ Services JJ Taxes less subsidies ▬▬ Real GDP growth, rhs Source: Statistics Agency of Kosovo and World Bank. Source: Statistics Agency of Kosovo and World Bank. Current Account Balance and FDI, 2011–15 General Government Deficit In percent of GDP By quarter, 2013–15, in euro In percent of GDP 10 600 4 5 2 500 0 0 400 -2 -5 -4 300 -10 -6 -15 200 -8 -10 -20 100 -12 -25 II III IV I II III IV I II III IV I II III IV I 0 -14 2011 2012 2013 2014 2015 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 JJ CAD JJ FDI net JJ Revenues JJ Expenditures ▬▬ Fiscal deficit, rhs Source: Central Bank of the Republic of Kosovo and World Bank. Source: Ministry of Finance and World Bank. Annual Growth in Loans, 2012–15 General Government Debt, 2008–14 In percent In percent of GDP 20 12 18 10.5 16 10 8.6 9.3 14 8 12 6.1 6.3 5.9 10 6 8 6 4 4 2 2 0 0 0 -12 Jul- 12 -1 3 Jul- 13 -1 4 Jul- 14 -1 5 Jul- 1 5 Jan Jan Jan Jan 2008 2009 2010 2011 2012 2013 2014 ▬▬ Total loans ▬▬ Loans to corporations ▬▬ Loans to households Source: Central Bank of the Republic of Kosovo. Source: Ministry of Finance. Nonperforming Loans, 2008–15 CPI and PPI. 2011–14 Percent of total loans Percent growth 10 12 9 10 8 7 8 6 6 5 4 4 3 2 2 1 0 0 -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 -08 -09 -09 -10 -10 -11 -11 -12 -12 -13 -13 -14 -14 -15 Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun 2011 2012 2013 2014 2015 ▬▬ CPI ▬▬ PPI Source: Central Bank of the Republic of Kosovo. Source: Statistics Agency of Kosovo. 64  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN KOSOVO 2012 2013 2014 2015f Real GDP growth (percent) 2.8 3.4 1.0 3.0 Composition (percentage points): Consumption 2.7 2.3 1.5 3.2 Investment -4.4 -0.1 0.4 1.4 Net exports 4.5 1.2 -0.9 -1.6 Exports 0.1 0.4 3.0 2.2 Imports (-) 4.4 0.8 -3.9 -3.8 Consumer price inflation (percent, period average) 2.5 1.8 0.4 -0.5 Public revenues (percent of GDP) 25.9 25.2 24.4 25.8 Public expenditures (percent of GDP) 28.5 28.1 27.0 28.3 Of which: Wage bill (percent of GDP) 8.1 7.9 8.9 9.3 Social benefits (percent of GDP) 3.7 4.1 4.9 5.4 Capital expenditures (percent of GDP) 10.8 10.1 7.5 7.6 Fiscal balance (percent of GDP) -2.6 -2.9 -2.6 -2.5 Primary fiscal balance (percent of GDP) -2.4 -2.5 -2.4 -2.2 Public debt (percent of GDP) 8.2 9.0 10.6 12.5 Public and publicly guaranteed debt (percent of GDP) 8.2 9.0 10.6 12.5 Of which: External (percent of GDP) 6.7 6.1 6.0 6.4 Goods exports (percent of GDP) 5.6 5.5 5.9 6.5 Goods imports (percent of GDP) 46.3 43.1 43.5 43.5 Net services exports (percent of GDP) 6.4 5.9 6.1 6.9 Trade balance (percent of GDP) -34.3 -31.8 -31.4 -30.2 Remittance inflows (percent of GDP) 12.0 11.7 12.7 13.5 Current account balance (percent of GDP) -7.5 -6.9 -8.1 -8.2 Foreign direct investment inflows (percent of GDP) 4.2 4.7 2.8 5.8 External debt (percent of GDP) 7.3 6.6 6.5 7.1 Real private credit growth (percent, period average) 5.8 1.9 3.0 5.1 Non-performing loans (percent of gross loans, end of period) 7.5 8.7 8.5 6.7 Unemployment rate (percent, period average) 30.9 30.0 35.3 33.3 Youth unemployment rate (percent, period average) 55.3 55.9 61.0 60.0 Labor force participation rate (percent, period average) 36.9 40.5 41.6 42.6 GDP per capita (US$) 3,600.7 3,877.2 3,990.1 3,548.9 Sources: Country authorities, World Bank estimates and projections. Notes: Credit growth for 2015 reflects year-to-date annual rolling averages. Non-performing loans show year-to-date actuals. SEE6 Country Notes  |  65 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 FYR Macedonia FYR Macedonia’s economic growth is expected reach 3.2 percent in 2015, supported by continued public investment and strong FDI-related exports. The continued expansion in economic activity reflects on the labor market outcomes with the unemployment rate down to 27.3 percent in the first quarter of 2015. However, relative to 2014, growth moderated in FYR Macedonia in the first half 2015, driven by slowdowns in manufacturing and services. Private consumption and investment also weakened following the recent political developments. The trade deficit narrowed down significantly in the first half of 2015 as exports outperformed imports, but net FDI inflows declined slightly in the same period. The public deficit for 2015 has been revised upwards after the government presented a supplementary budget with higher expenditures, particularly on transfers. While the political turmoil has moderated, it remains latent until elections take place in April 2016 and still represent a downside risk. High frequency data suggests a moderate, Contribution to GDP growth by sectors but widespread slowdown of economic In percent 5 activity in the second quarter of 2015, 7 possibly linked to the political turmoil faced by the country. Industrial production remained 4 stagnant in the second quarter of 2015, growing by 0.2 percent (y-o-y), which lowers average 2 3 growth for the first half of 2015 to 0.8 percent (y-o-y). The slowdown seemed widespread, 2 reaching apparel, mining, manufactures of tobacco products, non-metallic mineral -3 1 13 13 13 13 14 14 14 14 15 products and electrical equipment. In contrast, Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- JJ Agriculture JJ Mining, electricity, gas supply construction activities, measured by the value JJ Manufacturing JJ Construction JJ Wholesale & retail; transp.; Accommo. added of complete construction work, JJ Other services ▬▬ Real GDP growth, rhs rebounded in the second quarter of 2015. Source: State Statistics Office and World Bank staff calculations. On the demand side, consumption and increased by 3.3 percent (y-o-y) in real terms investment leading indicators provide and household credit growth remained robust mixed signals. VAT revenues and imports averaging 12 percent (y-o-y) in Q2 2015. We and domestic production of consumption project private consumption to be fueled by the goods have declined. However, retail trade announced increase in public wages, pensions 66  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN and social benefits (which accounts to more than and public administration. This result suggests one fifth of the population) in H2 2015. Gross a continuous decline in unemployment. investment also appears to have moderated as government capital investments and FDIs Export growth moderated slightly in the slowed down. Nevertheless, investment loans to second quarter of 2015, in part due to the companies increased by 7.6 percent (y-o-y) in developments in Greece, but continues to H1 2015 (compared to 4.4 percent increase for be higher than imports growth. Exports 2014). It is possible that a lack of resolution on increased by 9.9 percent (y-o-y) in EUR terms the political crisis continue to affect investment in Q2 2015 (compared to 13.6 percent in decision during the second half of the year. Q1), but declined by 11.9 percent (y-o-y) in US$ terms as the Denar (which is pegged to the Deflation persisted in the first half of 2015. EUR) depreciated vis-à-vis the US$. A decline Lower prices shifted to an increase of 0.5 percent in exports to Greece (amounting 0.6 % of total year-on-year in June, driven by increases in exports) helps explain this deceleration. Export food and energy prices. Nevertheless, prices growth was driven by FDI-related exports fell once again by 0.4 percent (y-o-y) in July and iron and steel products, while the more 2015 as energy prices declined. For the period “traditional” industries like apparel and tobacco January–July 2015, prices were 0.3 percent have declined. Overall exports increased by lower than a year earlier on average. 11.7 percent (y-o-y) in H1 2015 in EUR terms. Imports picked-up in Q2 2015, growing by Unemployment continues on a downward 9.1 percent (compared to 5.3 percent in Q1) trend in the first half of 2015, helped by in EUR terms and also declined in US$ terms. job creation in most sectors of the economy. Import growth was largely driven by raw- Unemployment, averaged 28 percent in 2014 materials used in the FDI sector. (one percentage point lower than in 2013). In the first quarter, unemployment averaged The trade deficit narrowed in the first half 27.3 percent, down from 28.4 percent a of 2015 and net inflows of FDI declined. year earlier. Youth unemployment declined The trade deficit narrowed by 35 percent in significantly to 48 percent in Q1 2015, after H1 2015 (y-o-y), as exports performed better increasing in 2014 to 53 percent, but it is than imports. Private transfers were slightly still among the highest in the region after lower than in H1 2014, but provided full Kosovo and Bosnia and Herzegovina. Long- coverage of the trade deficit, alleviating external term unemployment remains a problem, financing pressures. Net FDI inflows decreased as 46 percent of the unemployed had been by 40 percent (y-o-y), largely due to capital without a job from more than a year (as outflows registered in May 2015 (the height of measured by the Employment Agency). the political uncertainties in the country and High frequency data for Q2 2015 points to the Greek crises). Net inflows of FDI for 2015 an increased number of new job contracts, are estimated to reach 3.0 percent of GDP. consistent with the net employment creation trend observed in sectors such as construction, The Government adopted a supplementary manufacturing, business and financial services, budget in July 2015, which increased SEE6 Country Notes  |  67 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 expenditures and targets a higher deficit. issued EUR 121 million of new domestic Budget performance in the first half of 2015 debt in the first seven months of 2015 and was relatively good. On one hand, revenues plans to issue an additional EUR 263 million increased by 14 percent (y-o-y), largely thanks till the end of 2015 in order to accommodate to re-introduction of the corporate profit tax additional expenditures, the re-payment of and to strong performance of contributions, EUR 150 million Eurobond coming due in excises and personal income tax. On the other December 2015, and the pre-finance part of hand, expenditures increased only 5 percent the deficit level for 2016. (y-o-y) in the same period. Instead of using the extra revenues to frontload the announced Credit growth remained robust in the first fiscal adjustment, the Government opted for half of 2015, but declined slightly in May a supplementary budget that foresees higher and June, possibly affected by domestic and expenditures to accommodate increases in external developments. Stronger economic public wages, pensions and social transfers in activity and laxer credit requirements (especially H2 2015, estimated at around 0.2 percent of for SMEs) contributed to credit growth in the GDP. Subsidies and interest payments are also first four months of 2015 (10.2 percent y-o-y), expected to increase by 0.2 percent of GDP, particularly for corporate lending. Nevertheless, each. Finally, capital expenditures had also been credit growth slowed down to 9.2 percent y-o-y augmented by 0.2 percent of GDP, but given in May and June as the political turmoil and historical performance, they are hardly likely the crisis in Greece intensified. According to to be realized. As a result, the Government the latest Central Bank survey, banks expect increased the expected fiscal deficit for 2015 further relaxing of credit requirements for both from 3.5 to 3.7 percent of GDP. The revised corporate and household lending, supporting deficit is higher than the level announced in the strong credit growth in the coming period. 2015–2017 Medium-Term Fiscal Framework. Nonperforming loans (NPLs) remain elevated, averaging 11.3 percent in H1 2015, with Public debt as a share of GDP declined corporate NPLs standing at 15.7 percent in in the first half of 2015, but is expected June 2015. Deposit growth remains solid, but to increase again as the government has declined slightly in May and June. The loan-to- stepped-up its domestic borrowing. deposit ratio remains below the benchmark of Public debt stood at 43.7 percent of GDP 100 percent (at 91.5 in June 2015) and liquidity (as estimated by the Ministry of Finance) in the financial sector is high, indicating a in the first half of the year, declining from potential for further credit growth. 46.0 percent in end 2014. This decline was led by the pre-payment of the outstanding debt Political tensions decreased, but remain with the IMF (US$173 million). However, latent, as the political parties negotiate the the supplementary budget is expected to shift intern period till elections in April 2016. the Government financing structure in the Mediated by the EU and the US, the political second half of the year from mostly external to parties were able to reach an agreement on mostly domestic borrowing (at higher interest the intern period till the elections in April rate and shorter maturity). The government 2016. Under this agreement the current Prime 68  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN Minister (PM) should resign office in January 2016 and an intern PM should take his place and form a government with a specific mandate to organize the early elections. In addition, the political parties are negotiating a whole set of reforms including (i) appointment of a special public prosecutor with a mandate to investigate possible crimes related with the disclosed telephone conversations of government officials; (ii) appointment of new ministers and deputies proposed by the opposition to key ministries; (iii) changes in the country electoral system, including the state electoral committee and the electoral registry. According to this agreement the opposition agreed to return to the parliament in September 2015. Growth is expected to moderate to 3.2 percent in 2015, affected by the repercussions of the recent political turmoil. Public investment and FDI-related exports will remain the main drivers of growth in 2015. A number of public investment projects, which include the construction of two new highways are in full swing and should continue in the coming period. FDI related exports performed well in the past months and are expected to remain robust in 2015 and 2016. The announced pipeline of FDI inflows remains sizable, even though somewhat lower than before the crises. Nevertheless, the current political uncertainties pose a downside risk to the economy, especially to investment and consumption. Escalation of the current refugee crises may also pose a downside risk, especially to the government accounts. SEE6 Country Notes  |  69 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Business tendencies in the manufacturing Labor market developments industry Index In percent In percent 25 65 70 64 20 63 60 62 15 61 50 60 59 10 58 40 57 5 56 30 55 0 54 20 -12 Jul- 12 -13 Jul- 13 -14 Jul- 14 -15 4 5 6 7 8 9 0 1 2 3 4 200 200 200 200 200 200 201 201 201 201 201 Q1-1 5 Jan Jan Jan Jan JJ Average level of capacity utilization of the business entities, rhs ▬▬ Unemployment rate ▬▬ Employment rate ▬▬ Assessment of the current business situation of the business entity ▬▬ Activity rate ▬▬ Youth unemployment ▬▬ Confidence indicator Source: State Statistics Office and WB staff estimates. Source: State Statistics Office (Labor Force Survey) and World. CPI and its main components Current account balance, trade deficit and private transfers In percent y-o-y In percent of GDP 30 30 20 25 20 10 15 0 10 -10 5 -20 0 -5 -30 -10 -40 -15 10 11 11 12 12 1-13 3-13 1-14 3-14 1-15 Q3- Q1- Q3- Q1- Q3- Q Q Q Q Q 2006 2007 2008 2009 2010 2011 2012 2013 2014 ▬▬ CPI total ▬▬ Food & bev. ▬▬ Electr., gas, others ▬▬ Fuels & lubric. JJ Trade deficit JJ Private transfers ▬▬ Current account balance Source: State Statistics Office. Source: National Bank and WB staff calculations. Central Government budget execution Public debt by government levels In percent of GDP In percent of GDP 36 1 50 45 34 0 40 32 -1 35 30 30 -2 25 20 28 -3 15 26 -4 10 5 24 -5 0 Q2 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 JJ Budget balance, rhs JJ Upward budget balance revisions JJ Central government JJ Funds ▬▬ Revenues, lhs ▬▬ Expenditures, lhs JJ Municipalities JJ Guaranteed debt of SOEs Source: Ministry of Finance and WB staff estimates. Source: National Bank and WB staff calculations. Credit growth and contribution to credit growth Non-performing loans In percent In y-o-y percent change As percent of total in category 100 12 20 90 18 80 10 16 70 8 14 60 12 50 6 10 40 8 30 4 6 20 2 4 10 2 0 0 0 11 12 12 13 13 14 14 15 -11 Jul-11 an-12 Jul-12 an-13 Jul-13 an-14 Jul-14 an-15 Q4- Q2- Q4- Q2- Q4- Q2- Q4- Q2- Jan J J J J JJ Contrib. of hh loans JJ Contrib. of corp. loans ▬▬ Credit growth, rh ▬▬ Corporate NPLs ▬▬ Household NPLs ▬▬ Total NPLs Source: National Bank and WB staff calculations. Source: National Bank and WB staff calculations. 70  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN MACEDONIA, FYR 2012 2013 2014 2015f Real GDP growth (percent) -0.5 2.7 3.8 3.2 Composition (percentage points): Consumption 0.1 -0.5 0.3 0.1 Investment 1.9 0.4 3.2 3.5 Net exports -2.4 2.9 0.2 -0.4 Exports -2.0 -0.4 5.9 2.9 Imports (-) -0.5 3.3 -5.7 3.3 Consumer price inflation (percent, period average) 3.3 2.8 -0.3 0.5 Public revenues (percent of GDP) 32.1 30.2 29.8 31.0 Public expenditures (percent of GDP) 36.0 34.2 34.0 35.0 Of which: Wage bill (percent of GDP) 7.7 7.2 7.0 7.1 Social benefits (percent of GDP) 14.9 14.9 14.9 15.1 Capital expenditures (percent of GDP) 5.2 4.4 4.3 4.4 Fiscal balance (percent of GDP) -3.9 -4.0 -4.2 -3.9 Primary fiscal balance (percent of GDP) -3.0 -3.1 -3.2 -2.7 Public debt (percent of GDP) 33.7 34.2 38.2 40.2 Public and publicly guaranteed debt (percent of GDP) 38.3 40.5 46.0 48.4 Of which: External (percent of GDP) 25.6 25.6 31.9 29.2 Goods exports (percent of GDP) 30.4 29.2 32.5 32.8 Goods imports (percent of GDP) 56.9 52.2 54.3 53.6 Net services exports (percent of GDP) 4.0 4.4 4.2 3.8 Trade balance (percent of GDP) -22.5 -18.5 -17.6 -17.0 Remittance inflows (percent of GDP) 20.6 18.4 17.8 17.8 Current account balance (percent of GDP) -2.9 -1.8 -1.4 -2.8 Foreign direct investment inflows (percent of GDP) 1.5 3.3 3.3 3.0 External debt (percent of GDP) 66.1 64.0 69.8 70.4 Real private credit growth (percent, period average) 3.7 1.3 8.5 9.6 Non-performing loans (percent of gross loans, end of period) 10.3 11.3 11.1 11.2 Unemployment rate (percent, period average) 31.0 29.0 28.0 27.4 Youth unemployment rate (percent, period average) 54.0 51.9 53.1 49.1 Labor force participation rate (percent, period average) 56.5 57.2 57.3 57.3 GDP per capita, PPP (current international $) 11,669.4 12,263.5 12,937.9 13,330.0 National poverty rate (60% median equalized income, percent of 26.2 24.2 .. .. population) Sources: Country authorities, World Bank estimates and projections. Notes: Labor market indicators and credit growth for 2015 reflect year-to-date annual rolling averages. Non-performing loans show year-to-date actuals. Poverty rates are based on FYR Macedonia survey on income and living conditions (SILC). SEE6 Country Notes  |  71 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Montenegro Growth strengthened in the first half of 2015 boosted by rising domestic demand, as both consumption and investments surged. As positive developments continued in the beginning of the third quarter, for 2015 as a whole growth is expected to reach 3.4 percent as the Bar-Boljare highway section construction gets started in September and personal consumption strengthens amid a solid tourism season. Activity and employment rates improved to historical highs for Montenegro, but unemployment at 18 percent remains a challenge, especially among the most vulnerable groups. External imbalances deepened in 2015, as highway-related imports surged while exports of food, especially meat and electricity fell. While the fiscal deficit declined to 1.4 percent of GDP in 2014, highway construction costs (about 23 percent of GDP over four years) will likely increase the deficit to close to 6 percent of GDP in 2015 despite continued consolidation measures. A concomitant rise in public debt is expected to raise financing costs and risks over the medium term. Economic activity accelerated in early Construction also accelerated in the second 2015. Real GDP rose by 3.2 percent from quarter leading to a rise of 9.7 percent in the a year earlier in the first quarter of 2015 first half of the year. Although slightly decreased supported by domestic demand after increasing in March–May period, real retail trade 2.6 percent in the last quarter of 2014. recovered in June and further increased in July Personal and government consumption and by 3.8 percent y-o-y amid a solid tourism investment grew by 4.5 percent, 3.6 percent season. Growth of tourist arrivals and overnight and 6.8 percent y-o-y, respectively. At the same time, the contribution of net exports remained Real GDP, annual growth rates negative despite exports growing by 6.3 percent In percent 8 annually, driven mostly by tourism. 5.9 6 4.9 Favorable developments continued in the 4 3.6 4.1 3.2 2.9 2.6 second and the beginning of third quarter of 2 1.5 2.6 1.4 2015. Industrial production surged by 0.6 0.3 0 12.8 percent y-o-y in the second quarter and -0.5 33.6 percent in July driven by strong -2 -1.9 -2.3 -2.8 manufacturing production of pharmaceuticals, -4 -3.4 other non-metallic minerals, aluminum and -6 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 machinery and equipment. At the same time, 2011 2012 2013 2014 2015 Source: MONSTAT. food production declined significantly. 72  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN stays by July reached annual growth of 21.3 increased by 1 percent of GDP annually as percent and 28.6 percent, respectively. tourism continues to remain strong, as well as surplus on the income account which grew After deflation throughout 2014, inflation by 2.8 percent due to rise in compensation of was positive in 2015 supported by domestic employees and interest payments decline. On demand pick-up. Consumer prices increased the other hand, the merchandise deficit further 1.9 percent year-on-year in June and July, deteriorated as exports disappointed (mostly of after 2.3 percent in May, the highest rate since electricity and food, especially meat to Belarus, July 2013. In January–July, prices were up affected by Russian trade sanctions) and initial 1.5 percent y-o-y, boosted by food and clothes highway-related imports’ started to mount. prices, while oil prices fell. Cumulatively, in the first seven months of 2015, the merchandise deficit reached 42.1 percent of The labor market improved on the back GDP. of service sector employment. The survey data reports that unemployment dropped Montenegro continued attracting robust in the first half of 2015 by 3.2 percent y-o-y, foreign investments in real estate. Russian while the number of employed increased by citizens hold the largest share of real estate 2.5 percent resulting in a slight increase in among foreigners. Net FDI reached 10.7 percent labor force. In particular, new employment was of GDP in the twelve months to June 2015. generated in service activities and agriculture. However, debt-creating inflows remained high The unemployment rate decreased to a still leading to a further rise in external debt to high (a four-quarter average) 17.6 percent GDP ratio estimated at 121 percent. by June 2015, while both activity rate and employment rate increased to 53.1 percent and Current account balance 43.8 percent, respectively (both historical highs In USD billion In percent of GDP for Montenegro). Improvement continued 300 20 15 at the beginning of the third quarter, as 200 10 administrative employment data suggest a 100 5 further increase (1 percent y-o-y by July) 0 0 with the administrative unemployment rate -5 -100 declining to 14.7 percent in June and further -10 to 14.6 percent in July. -200 -15 -20 -300 -25 External imbalances deepened in 2014 and -400 I II III IV I II III IV I II III IV I II III IV I II III IV I II -30 first half of 2015 on the back of highway 2010 2011 2012 2013 2014 2015 ▬▬ Current account balance, rhs construction-related imports. A five-year JJ Current account balance Source: CBCG, MONSTAT, WB staff calculations. positive trend in declining external imbalances ended in 2014 with the current account deficit (CAD) reaching 15.4 percent of GDP and After months of declining, lending growth further increasing to 15.9 percent of GDP turned positive in May. After an increase in the first half of 2015. Services surplus of 1.1 percent in May total loans continued SEE6 Country Notes  |  73 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 to grow by 0.2 percent annually in June and by 0.5 percentage points) as well as pension July boosted by recovery of corporate sector indexation freeze in 2015 and abolishment of loans (0.3 percent) and continued increase of the privileged retirement schemes. However, loans to households (2.4 percent). In contrast, according to the Macroeconomic and Fiscal the government reduced its borrowing Policy Guidelines for 2015–2018 adopted in from the banking sector. At the same time, April, public spending in the next three years domestic deposits accelerated annual growth will be relatively high due to the highway to 13.2 percent in July reducing the loan- construction, reaching 49 percent in 2015 to-deposit ratio to 97.2 percent, the lowest before easing to 43 percent of GDP in 2018, level since August 2007. The share of non- with capital outlays amounting to about performing loans (NPLs) in total loans 9 percent of GDP every year. Excluding reached 16.4 percent in July, compared to highway costs, spending is expected to remain 15.9 percent at the end of 2014. In parallel, the flat in nominal terms. newly enacted Law on Consensual Financial Restructuring of Debts to Financial Institutions The general government cash deficit already (so-called Podgorica approach) will hopefully widened this year. The deficit grew to lead to voluntary resolution of bad assets to 3.2 percent of GDP in the first seven months of unlock further access to capital to corporates. 2015 due to expenditure growth of 7.7 percent In addition, in August 2015, the parliament y-o-y. The latter reflected a rise in capital adopted the law for conversion of Swiss franc expenditures, transfers to local governments to loans into euro which concerns one bank and help clear subnational arrears and larger interest 600 clients with indexed loans totaling some payments. The repayment of arrears (of pension EUR30 million (0.8 percent of GDP). The debt, court case resolutions, and utilities) whole amount of the exchange rate differences amounted to 1.4 percent of GDP. In the same have to be equally shared among the borrowers, period, revenues went up by only 2.9 percent the bank and the state. annually on the back of improved contribution collection and excises. Fiscal consolidation efforts moderated vulnerabilities in 2014. The fiscal deficit As the deficit widened, so did public debt. was reduced to 1.4 percent of GDP in 2014, Public debt increased by 22.2 percent in led by an equal revenue and expenditure nominal terms in the first half of 2015 compared consolidation effort. Public debt growth slowed to end-2014 on the back of external borrowing, down, although debt reached 60.5 percent of EUR500 million in Eurobonds to cover the GDP at the end of 2014. July bond redemption, and EUR170 million of the first Chinese EXIM Bank disbursement. In However, highway construction costs will relative terms, it reached 70.8 percent of GDP widen the fiscal deficits in 2015–2018. The (or 82.2 percent of GDP including guarantees). 2015 deficit was planned at 5.9 percent of GDP, Public debt is expected to reach 77 percent of in spite of the additional revenue measures GDP by 2018. Financing needs will double in (retaining the crisis PIT tax and increase in 2015 and 2016 to close to 16 percent of GDP, the rate of health insurance contribution with large Eurobond repayments coming due. 74  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN S&P affirmed the external (domestic) Europe and geopolitical tensions have minimal sovereign credit rating on Montenegro at direct impact on Montenegro, but carry B+(B) with stable outlook. It reflects a balance financial and growth risks via second-round of risks from worsening external, fiscal, and effects. Financial volatility caused by weaker general government debt metrics against the growth and financial turmoil in China and country’s growth potential over the coming anticipation of further monetary normalization 12 months. The rating could be lowered if: (i) in the US could put pressure on balance sheets the country’s fiscal metrics deteriorate further due to the highway loan denominated in US$ than currently envisaged (cost overruns related (EUR809 million). Any rise in the cost of to the highway construction, further costs financing, in particular for vulnerable emerging incurred in relation with legal proceedings and markets, would also lead to higher cost of debt restructuring of KAP, or expenditure overruns service. There are also additional risks on the from lower levels of government); (ii) the fiscal side that include the rollover of the 5-year country finds it harder to roll over its external Eurobond issue equivalent to 10 percent of debt; (iii) large-scale FDI projects stall or do not GDP maturing in 2016. The main domestic materialize as this would depress Montenegro’s risks refer to slow recovery of credit supply, and growth prospects. On the other side, the ratings delays in planned structural reforms, which would be raised if Montenegro’s economic are expected to raise potential growth once the growth will pick up faster than anticipated in highway construction ends. conjunction with a decline in the government and external debt. In July 2015, the Government adopted the Montenegro Development Directions for 2015–2018. This development strategy proposes ways for a long-term increase of living standards through alignment with the Europe 2020 strategy. Recognizing the available potential, tourism, energy, agriculture, rural development, and processing industry are emphasized as priority sectors of Montenegro’s development. Total estimated value of planned public and private sector investments during the three-year period amounts to EUR2.9 billion or close to 81 percent of current GDP. Growth is expected to pick up to 3.4 percent in 2015 driven by investment in public infrastructure and stronger tourism. The outlook has notable downside risks, external and domestic. The crisis in a country in Southeast SEE6 Country Notes  |  75 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 High frequency data, trend-cycle adjusted External trade series Index, 2011=100 Annual growth rates, percent, 3-month moving average 140 30 130 20 120 110 10 100 0 90 -10 80 -20 70 60 -30 last obs: 7/15 last obs: 7/15 50 -40 - 0 9 l-09 -10 l-10 -11 l-11 -12 l-12 -13 l-13 -14 l-14 -15 l-15 - 1 2 - 1 2 - 1 3 - 1 3 - 1 4 - 1 4 - 15 15 Jan Ju Jan Ju Jan Ju Jan Ju Jan Ju Jan Ju Jan Ju Jan Ju l Jan Ju l Jan Ju l Jan Jul- ▬▬ Total industry_tc ▬▬ Retail trade_tc ▬▬ Tourism_tc ▬▬ Imports ▬▬ Exports Source: MONSTAT, WB staff calculations. Source: MONSTAT, WB staff calculations. Labor market, administrative data General government deficit In thousands In EUR billion In percent of GDP 200 40 1,800 1 195 38 1,600 0 190 36 1,400 -1 185 34 1,200 180 32 1,000 -2 175 30 -3 170 28 800 600 -4 165 26 -5 160 24 400 155 last obs: 7/15 22 200 -6 150 20 0 -7 n - 10 ul-10 n-11 ul-11 n-12 ul-12 n-13 ul-13 n-14 ul-14 n-15 ul-15 Jan–Jul Ja J Ja J Ja J Ja J Ja J Ja J 2008 2009 2010 2011 2012 2013 2014 2015 ▬▬ Employment ▬▬ Employment_tc JJ Total revenue and grants JJ Total expenditure and net lending ▬▬ Unemployment, rhs ▬▬ Unemployment_tc, rhs ▬▬ Cash deficit, rhs ▬▬ Accrual deficit, rhs Source: MONSTAT, WB staff calculations. Source: MoF, MONSTAT, WB staff calculations. Labor market, survey-based data General government debt In percent In EUR billion In percent of GDP 60 25 3.0 80 50 2.5 70 20 60 40 2.0 50 15 30 1.5 40 10 30 20 1.0 5 20 10 0.5 10 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 0 0 0 5 f 6 f 7 f 2012 2013 2014 2015 2007 2008 2009 2010 2011 2012 2013 2014 201 201 201 JJ Participation rate JJ Employment rate JJ Foreign public debt JJ Domestic public debt ▬▬ Unemployment rate, rhs ▬▬ Public debt, rhs Source: MONSTAT. Source: MoF, MONSTAT, WB staff calculations. Loans and deposits, annual growth CPI and PPI, annual growth rates In percent In percent 15 8 10 6 4 5 2 0 0 -5 -2 -4 -10 -6 last obs: 7/15 last obs: 7/15 -15 -8 -1 1 11 -1 2 12 -13 13 -14 14 -15 15 10 ul-10 n-11 ul-11 n-12 ul-12 n-13 ul-13 n-14 ul-14 n-15 ul-15 Jan Jul- Jan Jul- Jan Jul- Jan Jul- Jan Jul- Ja n - J Ja J Ja J Ja J Ja J Ja J ▬▬ Total deposits ▬▬ Total bank loans ▬▬ CPI ▬▬ PPI Source: CBCG, WB staff calculations. Source: MONSTAT. 76  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN MONTENEGRO 2012 2013 2014 2015f Real GDP growth (percent) -2.5 3.3 1.5 3.4 Composition (percentage points): Consumption -2.0 1.2 1.4 0.3 Investment 0.6 0.6 1.3 5.9 Net exports -1.1 1.6 -1.1 -2.8 Exports -0.5 -0.6 -0.2 0.3 Imports (-) -0.6 2.1 -0.9 -3.1 Consumer price inflation (percent, period average) 4.1 2.2 -0.7 1.0 Public revenues (percent of GDP) 41.4 42.8 44.9 42.9 Public expenditures (percent of GDP) 47.2 47.6 46.2 48.8 Of which: Wage bill (percent of GDP) 13.4 12.7 12.8 12.2 Social benefits (percent of GDP) 15.3 14.5 14.4 14.1 Capital expenditures (percent of GDP) 4.4 4.1 5.5 9.5 Fiscal balance (percent of GDP) -5.9 -4.8 -1.4 -5.9 Primary fiscal balance (percent of GDP) -4.0 -2.7 0.9 -3.6 Public debt (percent of GDP) 54.0 58.1 60.5 65.7 Public and publicly guaranteed debt (percent of GDP) 66.1 67.5 69.5 77.1 Of which: External (percent of GDP) 53.2 52.5 57.3 67.4 Goods exports (percent of GDP) 12.4 11.9 10.4 10.1 Goods imports (percent of GDP) 56.6 51.8 50.6 50.3 Net services exports (percent of GDP) 19.4 19.6 20.2 19.4 Trade balance (percent of GDP) -24.7 -20.3 -20.0 -20.9 Remittance inflows (percent of GDP) 2.3 2.4 2.3 2.3 Current account balance (percent of GDP) -18.7 -14.6 -15.4 -16.0 Foreign direct investment inflows (percent of GDP) 14.7 9.7 10.3 10.7 External debt (percent of GDP) 115.1 115.4 120.7 129.4 Real private credit growth (percent, period average) -9.3 2.6 -2.5 -0.4 Non-performing loans (percent of gross loans, end of period) 16.5 17.5 15.9 16.2 Unemployment rate (percent, period average) 19.7 19.5 18.0 17.6 Youth unemployment rate (percent, period average) 43.7 41.6 35.8 36.3 Labor force participation rate (percent, period average) 49.8 50.1 52.7 53.1 GDP per capita, PPP (current international $) 13,588.9 14,135.6 14,323.3 14,624.0 Poverty rate at US$5/day, PPP (percent of population) 19.2 19.1 18.7 17.3 Sources: Country authorities, World Bank estimates and projections. Notes: Labor market and financial sector data for 2015 reflect year-to-date annual rolling averages unless otherwise stated. SEE6 Country Notes  |  77 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Serbia Serbia’s economy moved out of recession in the second quarter of 2015, growing by 1 percent year-on-year (y/y) following five consecutive quarters of decline in economic activity. Growth for 2015 as a whole is projected at 0.5 percent, compared to a contraction of 1.8 percent in 2014, because of the strong recovery of industrial production from the impact of the 2014 floods and improved external demand as EU growth has picked up. Fiscal performance in 2015 to date has out-performed expectations. Significantly higher revenues, although partly driven by one-off non-tax revenues, supported by a strict control of expenditures, led to a significantly lower fiscal deficit over the first seven months of 2015. However, public debt-to-GDP remains high, moving up to 73 percent at end-July. With the improved external environment supporting exports of goods and services, as well as remittances, the current account deficit in euro terms fell by 30 percent in the first half of the year compared to the same period 2014. Progress has also been seen on structural reforms as well, for example, with the financial consolidation plan of the electricity company approved and electricity prices increases, new laws on construction; inspections, and public sector employment enacted and implemented although in some areas, such as the resolution of socially owned enterprises from the Privatization Agency portfolio, progress was somewhat slower than earlier expected. Sustained implementation of the fiscal consolidation program, as supported by the IMF, including the set of structural reforms remains crucial in order to maintain macroeconomic stability and to create an environment conducive for faster growth. According to the latest estimates Serbia’s indeed declined by 1.7 percent y/y, but this real GDP grew by 1 percent y/y in Q2 was significantly less than previously projected 2015. The main driver was industry, whose as private sector wages started to increase, real value added was up 8.6 percent y/y in thus partially compensating for the decrease Q2 2015 (in part reflecting base effects as the in public sector wages over the same period. impact of the floods in May 2014 unwinds). Pensions, around 30 percent of the average In contrast, and dragging down overall growth, household’s income, declined by 4 percent y/y agriculture value added was hit by the recent (nominal) over the first five months. Investment drought, contracting by 9.4 percent y/y in real and exports increased significantly in Q2 (up terms. On the expenditure side, consumption 8.6 and 8.7 percent y/y respectively, again has been under pressure from cuts in public reflecting base effects from the 2014 floods as sector wages and pensions. In Q2 consumption well as improved external demand) supporting 78  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN the recovery, while government investment fell The annual 2015 fiscal deficit is now expected by 7.5 percent. to be significantly lower than the previously projected level of 5.9 percent of GDP. Once Real GDP Growth the impact of budget performance from the y/y, percent first seven months is taken into consideration, 4 the annual deficit may be around 4 percent of 3 GDP. One of the main risks to budget savings 2 is slippages on reforms to financial support to 1 SOEs, including the policy of no new liquidity 0 guarantees for SOEs. As the resolution of -1 the remaining SOEs in the Privatization -2 Agency portfolio has been partially delayed -3 (17 enterprises employing 21,500 people -4 received the one-year extension for completion -5 11 11 12 12 13 13 14 14 15 of privatization), fiscal risks stemming from Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Source: Statistics Office. the need to extend financial support to these enterprises have increased. The general government deficit over the first seven months of 2015 was 1 percent of full- The IMF reached a staff level agreement year GDP (versus 2.9 percent of GDP in the with authorities during the second same period of 2014). The deficit reduction review of Serbia’s precautionary Stand-By came primarily as a result of increased revenues Arrangement (SBA). The review recognized the (up 5.6 percent y/y in nominal terms). VAT government’s success in controlling its budget and excises pushed total tax revenues up by and structural reform progress (albeit uneven). 1 percent. However, the strong overall revenue The next review will be in late October, ahead performance was supported by a major increase of adoption of the 2016 budget. in non-tax revenues primarily due to one-off measures (i.e., payment of net income from Upward inflationary pressures have state owned enterprises and proceeds from the been limited by relatively weak domestic sale of 4G licenses) as well as by the introduction demand and the absence of adjustments of of surcharges on public sector wages. Total administratively controlled prices. Consumer nominal government expenditures declined by price inflation remained in the range of 1.8 percent as a result of major savings on wages 2 percent over H1 2015, below the target and pensions (down by 11.1 and 3.3 percent, band of the National Bank of Serbia (NBS) respectively). Despite lower net fiscal financing of 4 +/-1.5 percent, and slowed to 1 percent needs, central government debt (including (y/y) in July, primarily as a result of lower food guarantees) moved up to 73 percent at end- price inflation. Food price inflation in H1 was July 2015 from 71.0 percent at end-2014, in 3 percent while in July it was just 0.6 percent. part due to US dollar strength earlier in 2015 Core inflation peaked in March at 2.9 percent, (33 percent of the total stock of debt is dollar- falling thereafter, down to 2.2 percent in May denominated). (the latest available data). In coming months, SEE6 Country Notes  |  79 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 inflation is expected to rise more significantly the first half of 2015 was 30 percent lower than following August’s electricity price increase, in the same period of 2014. Over this period, bringing inflation back up into the target band export of both goods and services rose notably by year-end. (5.8 and 15 percent respectively). Net transfers also improved, as remittance inflows rose by Inflation 12.9 percent y/y, in euro terms. In the financial y/y, percent account there was a further decrease of net 14 FDI in H1 by 4.3 percent y/y (in euro terms) 12 in the absence of any major new projects. 10 Nevertheless, FDI net-inflow almost entirely 8 covered the CAD in H1. 6 4 The Dinar remained broadly stable in 2 nominal terms through August 2015. Unlike 0 in 2014, when the NBS intervened heavily in order to prevent a significant depreciation -2 -12 Jul- 12 -13 Jul- 13 -14 Jul- 14 -15 Jul- 15 of the currency, this year NBS has been a Jan Jan Jan Jan ▬▬ CPI, total ▬▬ CPI, excl. food ▬▬ Target, upper ▬▬ Target, lower net-purchaser of euros in order to prevent Source: National Bank of Serbia. appreciation of the dinar as the current account balance has improved. After falling significantly The recovery in activity was reflected in the in Q4 2014, official reserves increased by EUR labor market with the unemployment rate 723 million over the first seven months, in part declining to 17.9 from 19.2 percent in Q1. likely reflecting valuation effects as the dollar Relative to the previous quarter, the number appreciated against the Euro, and stood at EUR of employed rose by 2.9 percent, mainly 10.6 billion at the end of July. due to the creation of formal full-time jobs (informal employment actually went down by After a short-lived recovery, largely driven 1.7 percent). As a result, the employment rate by lending to SOEs, credit activity slowed. reached 42.3 percent, the highest level since Loans were up 4.7 percent y/y over the first Q2 2009. As mentioned, while private sector seven months 2015 (not adjusted for currency wage growth was positive (3.4 percent y/y in movements). While loan growth to enterprises nominal terms over the first five months 2015), turned positive, this was entirely driven by public sector wages declined (down 6.4 percent lending to SOEs as loans to private enterprises y/y over the same period). As a result, overall declined by 4.2 percent y/y over the first seven real wages fell again over the first six months months. The NBS is more actively working of 2015, down 1.6 percent y/y following a on the resolution of the longstanding problem reduction of wages by 0.7 percent in real terms of non-performing loans, which accounted over 2014 as a whole. for 22.8 percent of total loans in June 2015, under the new Action Plan for NPLs resolution External adjustment continues. The current (approved in August). Developments in Greece account deficit (CAD) of EUR 728 million in to date have not had a major impact on the 80  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN Serbian banking sector with the authorities and downside risks to the outlook. The extent taking proactive policy measures and total of the support to growth from the recovery in deposits remained broadly flat over recent the Euro zone and global economy is a one risk months. The NBS continues to take steps to to the outlook. Turbulence in international provide supportive monetary policy, given financing conditions could also spill over to tightening fiscal conditions, improved capital the domestic economy via access to external inflows but still weak growth, and lowered the financing (although this risk is mitigated by key policy rate to 5.5 percent on August 13th. the government’s reduced financing needs in 2015). Outlook Serbia’s economy is expected to return to growth of 0.5 percent in 2015, supported by improved external demand and the recovery from the 2014 floods. The baseline scenario assumes ongoing progress on core structural and fiscal reforms. Most importantly, Serbia is expected to come close to completing the resolution of a significant portfolio of enterprises managed by the Privatization Agency and to continue with public administration rightsizing. Although these reforms may have immediate adverse impacts for the employment and living standards of those directly affected, household consumption is expected to recover gradually over 2015 as a whole, as well as government investment. In addition, external factors should help to support Serbia’s near- term macro outlook. Nevertheless, over the medium term, the macro-fiscal outlook for Serbia remains fragile and highly dependent upon the implementation of the government’s fiscal consolidation and structural reform program. However, if successfully implemented reforms should help Serbian economy to grow at about 1.5 and 2.5 percent in 2016 and 2017, respectively. The outlook for external demand, as well as internal reform progress, poses both upside SEE6 Country Notes  |  81 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Industrial output growth Unemployment rate y/y, percent percent 35 50 25 40 15 5 30 -5 20 -15 10 -25 -35 0 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 -12 -13 -13 -13 -13 -14 -14 -14 -14 -15 -15 Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun 2009 2010 2011 2012 2013 2014 2015 JJ 3m/3m, SA, ann ▬▬ y/y, 3m MA JJ Activity rate JJ Employment rate JJ Unemployment rate Source: Statistics Office. Source: LFS, Statistics Office. Nominal loan growth Export value growth y/y, percent y/y, percent 25 50 20 40 15 30 10 20 5 0 10 -5 0 -10 -10 -15 -20 -12 Jul- 12 -13 Jul- 13 -14 Jul- 14 -15 Jul- 15 Jan Jan Jan Jan Q1 Q2 Q3 Q4 ▬▬ Loans to enterprises ▬▬ Loans to households ▬▬ Loans to private enterpr. JJ 2013 JJ 2014 JJ 2015 Source: National Bank of Serbia. Source: Statistics Office. Quarterly fiscal deficits Government debt-to-GDP percent of quarterly GDP percent 0 80 -2 70 60 -4 50 -6 40 -8 30 20 -10 10 -12 0 Q1 Q2 Q3 Q4 2009 2010 2011 2012 2013 2014 Jul-15 JJ 2013 JJ 2014 JJ 2015 JJ External direct debt JJ Domestic direct debt JJ Guarantees Source: Ministry of Finance. Source: Ministry of Finance - Public Debt Administration. 82  | SEE6 Country Notes GROWTH RECOVERS, RISKS HEIGHTEN SERBIA 2012 2013 2014 2015f Real GDP growth (percent) -1.0 2.6 -1.8 0.5 Composition (percentage points): Consumption -1.2 -0.6 -1.0 -1.1 Investment 0.6 -1.5 -0.7 1.1 Net exports -0.4 4.8 -0.2 0.6 Exports 0.3 7.4 1.6 3.9 Imports (-) -0.7 -2.6 -1.8 -3.3 Consumer price inflation (percent, period average) 7.3 7.7 2.1 1.6 Public revenues (percent of GDP) 39.4 37.9 40.0 40.1 Public expenditures (percent of GDP) 46.6 43.5 46.7 44.1 Of which: Wage bill (percent of GDP) 10.5 10.1 10.0 9.1 Social benefits (percent of GDP) 18.7 17.2 17.8 17.7 Capital expenditures (percent of GDP) 3.3 2.1 2.5 3.1 Fiscal balance (percent of GDP) -7.2 -5.6 -6.7 -4.0 Primary fiscal balance (percent of GDP) -5.3 -3.2 -3.7 -0.6 Public debt excluding guarantees (percent of GDP) 50.1 53.1 63.3 70.0 Public and publicly guaranteed debt (percent of GDP) 58.3 61.4 71.0 76.7 Of which: External (percent of GDP) 33.2 35.7 43.1 49.0 Goods exports (percent of GDP) 26.5 30.7 32.2 35.1 Goods imports (percent of GDP) 44.3 42.8 44.6 46.2 Net services exports (percent of GDP) 0.4 0.9 1.4 2.1 Trade in goods and services balance (percent of GDP) -17.5 -11.2 -11.0 -9.0 Remittance inflows (percent of GDP) 6.1 6.3 5.6 6.6 Current account balance (percent of GDP) -11.6 -6.1 -6.0 -4.0 Foreign direct investment inflows (percent of GDP) 2.4 3.8 3.7 4.0 External debt (percent of GDP) 81.2 75.1 78.4 80.9 Real private credit growth (percent, period average) 6.3 -9.2 -4.0 -1.4 Non-performing loans (percent of gross loans, end of period) 18.6 21.4 23.0 22.8 Unemployment rate (percent, period average) 24.0 22.1 18.9 17.9 Youth unemployment rate (percent, period average) 51.0 49.4 47.0 43.6 Labor force participation rate (percent, period average) 56.5 57.2 57.3 57.3 GDP per capita, PPP (current international $) 12,790.8 13,380.2 13,329.2 13,380.4 Sources: Country authorities, World Bank estimates and projections. Notes: Labor market indicators and credit growth for 2015 reflect year-to-date annual rolling averages. Non-performing loans show year-to-date actuals. SEE6 Country Notes  |  83 SEE6: Key Economic Indicators GROWTH RECOVERS, RISKS HEIGHTEN SEE6:  Key Economic Indicators 2012 2013 2014 2015f 2016f 2017f Real GDP growth (percent) Albania 1.6 1.1 2.1 2.7 3.4 3.5 Bosnia and Herzegovina -1.2 2.5 0.8 1.9 2.3 3.1 Kosovo 2.8 3.4 1.0 3.0 3.5 3.7 Macedonia, FYR -0.5 2.7 3.8 3.2 3.4 3.7 Montenegro -2.5 3.3 1.5 3.4 2.9 3.0 Serbia -1.0 2.6 -1.8 0.5 1.5 2.0 SEE6 -0.4 2.5 0.3 1.8 2.4 2.8 Consumer price inflation (percent, period average) Albania 2.0 1.9 1.6 2.1 Bosnia and Herzegovina 2.0 -0.1 -0.9 0.5 Kosovo 2.5 1.8 0.4 -0.5 Macedonia, FYR 3.3 2.8 -0.3 0.5 Montenegro 4.1 2.2 -0.7 1.0 Serbia 7.3 7.7 2.1 1.6 SEE6 4.6 4.2 0.9 1.2 Public expenditures (percent of GDP) Albania 28.2 28.9 32.0 32.1 31.4 30.1 Bosnia and Herzegovina 46.6 45.6 46.4 45.8 45.2 44.9 Kosovo 28.5 28.1 27.0 28.3 28.4 27.5 Macedonia, FYR 33.4 31.9 32.0 32.7 32.3 31.8 Montenegro 47.2 47.6 46.2 48.8 47.3 45.8 Serbia 46.6 43.5 46.7 44.1 42.1 40.3 SEE6 38.4 37.6 38.4 38.6 37.8 36.7 Public revenues (percent of GDP) Albania 24.7 23.7 26.2 27.0 27.0 27.1 Bosnia and Herzegovina 44.5 43.4 44.4 43.9 43.4 43.2 Kosovo 25.9 25.2 24.4 25.8 25.4 25.0 Macedonia, FYR 29.6 28.1 27.8 28.8 28.8 28.8 Montenegro 41.4 42.8 44.9 42.9 41.9 41.4 Serbia 39.4 37.9 40.0 40.1 38.1 37.2 SEE6 34.2 33.5 34.6 34.8 34.1 33.8 SEE6: Key Economic Indicators  |  87 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.8 Fiscal balance (percent of GDP) Albania -3.5 -5.2 -5.8 -5.1 -4.4 -3.0 Bosnia and Herzegovina -2.0 -2.2 -2.1 -1.9 -1.8 -1.7 Kosovo -2.6 -2.9 -2.6 -2.5 -3.0 -2.5 Macedonia, FYR -3.8 -3.9 -4.2 -3.9 -3.5 -3.0 Montenegro -5.9 -4.8 -1.4 -5.9 -5.5 -4.4 Serbia -7.2 -5.6 -6.7 -4.0 -4.0 -3.1 SEE6 -4.2 -4.1 -3.8 -3.9 -3.7 -3.0 Public debt (percent of GDP) Albania 58.0 66.3 68.4 68.5 65.1 60.2 Bosnia and Herzegovina 38.8 37.2 38.7 42.1 39.2 36.8 Kosovo 8.2 9.0 10.6 12.5 13.9 15.6 Macedonia, FYR 33.7 34.2 38.2 40.2 40.1 40.8 Montenegro 54.0 58.1 60.5 65.7 68.5 70.4 Serbia 47.8 50.5 61.1 70.0 73.0 73.4 SEE6 40.1 42.6 46.3 49.8 50.0 49.5 Public and publicly guaranteed debt (percent of GDP) Albania 62.0 70.1 72.5 73.2 70.0 65.4 Bosnia and Herzegovina 43.6 41.6 42.7 46.1 43.0 40.4 Kosovo 8.2 9.0 10.6 12.5 14.2 16.0 Macedonia, FYR 38.3 40.5 46.0 48.4 49.2 50.6 Montenegro 66.1 67.5 69.5 77.1 79.3 80.8 Serbia 56.1 58.8 68.8 76.7 78.4 77.7 SEE6 45.7 47.9 51.7 55.7 55.7 55.1 Goods exports (percent of GDP) Albania 15.9 18.1 9.2 8.2 Bosnia and Herzegovina 22.6 24.3 24.6 25.1 Kosovo 5.6 5.5 5.9 6.5 Macedonia, FYR 30.4 29.2 32.5 32.8 Montenegro 12.4 11.9 10.4 10.1 Serbia 26.5 30.7 32.2 35.1 SEE6 22.5 24.7 24.4 25.5 Trade balance (percent of GDP) Albania -18.7 -17.9 -18.7 -18.9 Bosnia and Herzegovina -24.0 -20.8 -23.3 -20.0 Kosovo -34.3 -31.8 -31.4 -30.2 Macedonia, FYR -22.5 -18.5 -17.6 -17.0 Montenegro -24.7 -20.3 -20.0 -20.9 Serbia -17.5 -11.2 -11.0 -9.0 SEE6 -21.1 -16.9 -17.3 -15.8 88  | SEE6: Key Economic Indicators GROWTH RECOVERS, RISKS HEIGHTEN Current account balance (percent of GDP) Albania -10.2 -10.7 -13.0 -13.1 -13.4 -12.6 Bosnia and Herzegovina -8.8 -5.7 -7.7 -7.9 -6.0 -6.5 Kosovo -7.5 -6.9 -8.1 -8.2 -8.0 -7.9 Macedonia, FYR -2.9 -1.8 -1.4 -2.8 -3.1 -3.0 Montenegro -18.7 -14.6 -15.4 -16.0 -16.4 -16.8 Serbia -11.6 -6.1 -6.0 -4.0 -4.0 -3.8 SEE6 -9.8 -6.6 -7.3 -6.7 -6.5 -6.4 External debt (percent of GDP) Albania 35.6 34.3 36.7 42.3 45.6 43.8 Bosnia and Herzegovina 52.2 50.8 54.6 54.2 54.5 54.0 Kosovo 7.3 6.6 6.5 7.1 7.6 7.2 Macedonia, FYR 66.1 64.0 69.8 70.4 71.0 70.8 Montenegro 115.1 115.4 120.7 129.4 140.9 147.2 Serbia 81.2 75.1 78.4 80.9 86.3 83.6 SEE6 59.6 57.7 61.1 64.1 67.6 67.8 Unemployment rate (period average, percent) Albania 13.4 16.0 17.5 17.1 Bosnia and Herzegovina 28.1 27.4 27.5 27.7 Kosovo 30.9 30.0 35.3 33.3 Macedonia, FYR 31.0 29.0 28.0 27.4 Montenegro 19.7 19.5 18.0 17.6 Serbia 24.0 22.1 18.9 17.9 SEE6 23.9 23.3 22.4 21.6 Source: World Bank calculations and projections based on data from national authorities and World Economic Outlook (2015). SEE6: Key Economic Indicators  |  89