WESTERN BALKANS REGULAR ECONOMIC REPORT No.16 | Fall 2019 Rising Uncertainties Western Balkans Regular Economic Report No.16 Rising Uncertainties Fall 2019   Acknowledgements This Regular Economic Report (RER) covers economic developments, prospects, and economic policies in the Western Balkans’ region: Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia. The team was led by Marc Tobias Schiffbauer and Edith Kikoni (Task Team Leaders). This issue’s core team included World Bank staff working on the Western Balkan countries (with additional contributions to specific sections): Bojan Shimbov, Sandra Hlivnjak (External section), Milan Lakićević (Fiscal section), Hilda Shijaku, Johanna Jaeger, and Christoph Ungerer (Monetary and Financial section), Sanja Madžarević-Šujster (Labor section), Asli Senkal and Milan Lakićević (Growth section), and Lazar Šestović, Natasha Rovo (Outlook section). Additional contributions were made by: Stefanie Brodmann (Labor section); Alena Kantarovich (Financial sector section); Christoph Ungerer (Fiscal section); Alen Mulabdic (External section); and Collette Wheeler and Julia Norfleet (Outlook Section). Anne Grant provided assistance in editing, and Budy Wirasmo assistance in designing. Valentina Martinovic, Nejme Kotere, Samra Bajramovic, Ivana Bojic, Eranda Troqe, Hermina Vukovic Tasic, Jasminka Sopova, Boba Vukoslavovic, Dragana Varezić, and Leah Laboy assisted the team. The dissemination of the report and external and media relations are managed by an External Communications team comprised of Lundrim Aliu, Anita Božinovska, Paul A. Clare, Ana Gjokutaj, Jasmina Hadžić, Carl P. Hanlon, Vesna Kostić, John Mackedon, Mirjana Popović, Kym Louise Smithies, and Sanja Tanić. The team is grateful to Linda Van Gelder (Regional Director for the Western Balkans); Lalita Moorty (Regional Director, Equitable Growth, Finance and Institutions); Gallina A. Vincelette (Practice Manager, Macroeconomics, Trade, and Investment Global Practice); and the Western Balkans 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 the Ministries of Finance and Central Banks in Western Balkans countries. This Western Balkans RER and previous issues may be found at: www.worldbank.org/eca/wbrer/. © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Contents Rising Uncertainties 1 1. Overview 2 Growth slows with lower contributions from exports and investments 2.  5 As employment picked up in 2019, unemployment fell to historic lows 3.  9 Rising uncertainties call for rapid improvement in public finances 4.  14 5.  Positive credit growth is driven by household lending 21 6.  Exports slow amid rising international trade tensions 26 The outlook is positive but vulnerable to rising external risks 7.  29 Country Notes 33 Albania34 Bosnia and Herzegovina 39 Kosovo44 Montenegro49 North Macedonia 54 Serbia59 Key Economic Indicators 65 vi  | Contents RISING UNCERTAINTIES List of Figures Figure 1.1. After strong growth in 2018, employment increased. 4  ut economic growth is slowing in 2019 with lower contributions from Figure 1.2. B exports and investment. 4  rowth is slowing despite a surge in public spending and widening Figure 1.3. G internal imbalances… 4 Figure 1.4. …at a time when external imbalances are also growing. 4  e positive outlook for 2020–21 is thus surrounded by downside risks, Figure 1.5. Th including higher external risks amid rising trade tensions. 4  e global economy continues to slow adding to rising uncertainties. Figure 1.6. Th Creating more job opportunities thus requires strong commitment to structural reforms to unleash productivity. 4 Figure 2.1. In 2019 growth in the Western Balkans is projected to decelerate. 5 Figure 2.2. Higher public spending supported consumption and investment growth in 2018. 5 Figure 3.1. Employment picked up and… 9 Figure 3.2. …unemployment fell in all Western Balkans countries. 9 Figure 3.3. Kosovo’s 2016 labor market gains were nullified. 11 While more people joined the labor force and found jobs, progress is slow Figure 3.4.  and uneven. 11 Figure 3.5. In some countries, inactivity is high and heading up. 12 Figure 3.6. The female–male labor participation gap narrowed to below 18 percentage points. 12 Figure 3.7. While across the region minimum wages have gone up recently... 13 Figure 3.8. ...in several countries productivity has not. 13  e fiscal deficit is projected to go up in all countries except Kosovo and Figure 4.1. Th Montenegro…14 Figure 4.2. …higher revenues are offset by a surge in spending. 14 Figure 4.3. Social benefits are driving increased government spending… 15 Figure 4.4. …and together with public wages account for over half of total spending. 15  ublic and publicly guaranteed debt (PPG) rises in Montenegro, North Figure 4.5. P Macedonia, and Kosovo… 18  and external PPG debt is expected to go up in Montenegro, Serbia, Figure 4.6. … and North Macedonia. 18 Figure 5.1. Inflation is trending down, tracking global food and oil prices. 21 Figure 5.2. Core inflation remains subdued. 21 Figure 5.3. Central banks in North Macedonia and Serbia further lowered policy rates… 22 Figure 5.4. …and Serbia intervened in foreign exchange markets. 22 Figure 5.5. Credit outstanding continued to be positive throughout the region. 22 Figure 5.6. Credit to households grew consistently, but not credit to firms. 22 Figure 5.7. Nonperforming loans are declining. 23 Figure 5.8. Banks are adequately capitalized. 23 Figure 6.1. By yearend-2019, the CAD is expected to widen slightly for the region… 26 Contents  |  vii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Figure 6.2. …mainly because of rising imports for infrastructure projects. 26 Figure 6.3. Total FDI inflows to the region were generally steady in 2019… 28 Figure 6.4. …but net FDI inflows fell in North Macedonia and Serbia. 28 List of Tables Table B.4.1. Recent Eurobond issuances in the Western Balkans. 19 Table 7.1. Growth Rates in the Western Balkans, 2017–21f 29 List of Boxes Box 2.1. Low productivity limits Western Balkan’s potential output 7 Box 3.1. Unemployment declines in the Western Balkans 10 Box 4.1. Fiscal Rules in the Western Balkans: What Does the Public Say? 16 Box 4.2. Recent Eurobond Developments in the Western Balkans. 19 Box 5.1. The Assessment Framework on Preconditions and Capital Market Development 24 Box 6.1. The Central European Free Trade Agreement (CEFTA) 27 Box 7.1. Emerging Global Risks 30 viii  | Contents Rising Uncertainties WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 1. Overview Supported by strong economic growth in consumption continues to be the main driver of 2018, unemployment fell to historic lows economic activity in Western Balkan countries. in the first half of this year. By June 2019, Consumption growth has been fueled by higher 150,000 additional jobs have been created in public spending and near double-digit growth the Western Balkans compared to a year earlier. in household lending, raising questions on Some 43,000 young people have found jobs, the sustainability of the consumption-driven especially in Albania, as youth unemployment growth in the region. in the region has fallen supported by the growing business-process outsourcing sector. And internal and external imbalances are Economic activity in 2018 has also attracted rising. Growth is slowing despite a surge more women into the labor force. Despite in public spending stimulated by buoyant these positive labor market developments, cyclical revenues. The rise in revenues has less than half of those of working-age in the not been enough to offset the rise in current Western Balkans have a job (44 percent). In spending which was dominated by public Bosnia and Herzegovina and in Kosovo, only wages and social benefits, including higher 34 percent and 30 percent of the working-age spending on untargeted social programs in population has a job and youth unemployment Bosnia and Herzegovina and Kosovo. As a remains high in both countries. Sustaining result, fiscal deficits are projected to go up in high and equitable economic growth is thus 2019 in all countries in the Western Balkans essential to create many more, much-needed except Kosovo and Montenegro. External job opportunities in the region. imbalances also started to rise as exports slow because of falling demand from EU trading But economic growth in the Western partners amid rising trade tensions. The current Balkans is slowing after a short-lived revival account deficit (CAD) is expected to go up in in investment in previous years. In 2019, all Western Balkan countries in 2019. Stable economic growth in the Western Balkans is remittances and foreign direct investments projected to reach 3.2 percent, down from (FDI) help finance the CAD. Nevertheless, 3.9 percent in 2018. Except for Kosovo sizeable external imbalances in several Western and North Macedonia, where growth has Balkan countries, together with elevated public continued to recover after a major slowdown, debt, expose the region to adverse economic growth is expected to be lower than in 2018 shocks. The higher public spending has thus in all other countries. Economic growth slows compromised an opportunity to build the as the contribution of investment and exports much-needed fiscal buffers to be able to cushion to growth is fading in several countries in the the impact of rising external uncertainties. region. Net exports continue to subtract from growth, as the region’s trailing competitiveness The positive outlook for 2020–21 masks weighs on opportunities for its small open underlying vulnerabilities as downside economies to access larger markets. Instead, risks intensify. All countries are projected 2  |  1. Overview RISING UNCERTAINTIES to grow faster, except Montenegro, where management reforms are needed as a part of the phasing-out of an investment cycle is broader structural reforms that help increase the projected to moderate growth somewhat. In region’s export competitiveness. This includes several countries, however, the positive outlook strengthening state institutions that protect the reflects one-time factors. In Albania, energy rule of law and private sector competition to production is expected to rebound as rainfall unleash productivity growth and innovation is assumed to return to historical averages. In by enabling a level playing field between firms. Kosovo and in Bosnia and Herzegovina, public Together, these reforms would help unlock investment is expected to pick up. In Serbia, stronger, more equitable, and more sustainable the contribution to growth from consumption growth, ensuring faster convergence with EU is expected to continue to accelerate in 2020 as income levels. A strong commitment to sound increases in public sector wages and pensions macro-fiscal policy and structural reforms was materialize. However, the positive outlook is always important—rising uncertainties have vulnerable to mounting downside risks. The made it an imperative. region faces rising uncertainty as economic growth slows globally, including in the EU— the Western Balkans’ major trading partner and source of financial flows. Rising trade tensions and oil price volatility further raise the external risks. At the same time, elevated political polarization in several countries in the region, as well as weather-related shocks affecting agricultural and energy production, add to domestic uncertainties. Rising uncertainties call for rapid improvement in public finances and competitiveness. Improving the efficiency and equity of public spending and strengthening revenue mobilization remains a priority in all Western Balkan countries. Public sector wage bills and pensions constitute the largest share of public spending in the region. Tighter controls on wage bills, reducing tax expenditures, and better targeting of social benefits would open space for more public investment, improve equity, and enable the build-up of fiscal buffers to mitigate rising risks. As outlined in this report, fiscal rules can help anchor spending and fiscal sustainability. However, their credibility in the region needs to be restored after they have been repeatedly breached in some countries. Fiscal 1. Overview  |  3 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Figure 1.1. After strong growth in 2018, Figure 1.2. But economic growth is slowing employment increased. in 2019 with lower contributions from exports and investment. Labor market status, percent of working-age population Contribution of factors to real GDP growth, percentage points 100 10 90 8 80 70 6 60 4 50 2 40 30 0 20 -2 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 2018 2018 2018 2018 2018 2018 2018 10 -4 e e e e e e e 20 8 20 8 20 8 20 8 20 8 20 8 20 8 0 19 19 19 19 19 19 19 1 1 1 1 1 1 1 20 20 20 20 20 20 20 KOS MKD BIH MNE ALB SRB WB6 ALB BIH KOS MKD MNE SRB WB6 JJEmployed JJUnemployed JJInactive JJConsumption JJInvestment JJNet exports QQReal GDP growth Source: National authorities and World Bank estimates. Source: National statistical offices. Note: June 2019 data refer to 4-quarter moving average. Figure 1.3. Growth is slowing despite a surge Figure 1.4. …at a time when external in public spending and widening internal imbalances are also growing. imbalances… Fiscal deficits, percent of GDP Estimated CAD changes, percent of GDP 6 MNE KOS ALB SRB BIH MKD WB6 5 0 4 -2 3 -4 2 -6 1 -8 0 -10 -1 -12 -2 -14 -3 -16 MNE KOS MKD ALB BIH SRB WB6 -18 JJ2017 JJ2018 JJ2019e JJ2017 JJ2018 JJ2019e Source: National authorities and World Bank estimates. Source: National authorities and World Bank estimates. Figure 1.5. The positive outlook for 2020– Figure 1.6. The global economy continues to 21 is thus surrounded by downside risks, slow adding to rising uncertainties. Creating including higher external risks amid rising trade more job opportunities thus requires strong tensions. commitment to structural reforms to unleash productivity. Growth rates, 2017–21f, percent Growth forecasts, percent 3.2 5.2 2017 2018 2019e 2020f 2021f Albania 3.8 4.1 2.9 3.4 3.6 2.8 4.8 Bosnia and 3.2 3.6 3.1 3.4 3.9 Herzegovina Kosovo 4.2 3.8 4.0 4.2 4.1 2.4 4.4 North Macedonia 0.2 2.7 3.1 3.2 3.3 Montenegro 4.7 4.9 3.0 2.8 2.7 2.0 4.0 Serbia 2.0 4.2 3.3 3.9 4.0 Western Balkans 2.6 3.9 3.2 3.6 3.8 1.6 3.6 EU28 2.5 2.0 1.4 1.3 1.4 -18 un-18 ug-18 ct-18 ec-18 eb-19 pr-19 un-19 ug-19 Apr J A O D F A J A ▬▬World ▬▬Advanced economies ▬▬EMDEs, rhs Source: World Bank estimates (see text for details). Source: Western Balkans Urbanization and Territorial Review, World Bank. 4  |  1. Overview RISING UNCERTAINTIES Growth slows with lower contributions from exports and 2.  investments Growth in the Western Balkans is projected expected to moderate to 3 percent from a high to slow from a high of 3.9 percent in 2018 to of 4.9 percent in 2018 as the public investment 3.2 percent in 2019 ( Figure 2.1). Except for cycle is phased out. North Macedonia, where growth has continued to pick up after a major slowdown in 2017, and Consumption continues to be the main driver Kosovo, where it is expected to remain strong at of economic activity this year, supported 4.0 percent, in the rest of the region growth will by higher consumer lending and wage and be somewhat lower than in 2018. By yearend, employment growth. All countries in the growth in North Macedonia is projected to region but Montenegro and Albania saw public reach 3.1 percent, driven by higher investment. wages go up, boosting consumption (Figure In Kosovo growth is expected to be driven 2.2). In Serbia and North Macedonia, pension mainly by consumption and service exports. increases strengthened total consumption, Serbia, the largest economy in the region, which is projected to contribute 4.4 pp to is expected to grow at 3.3 percent in 2019, growth in Serbia, the strongest in the Western down from 4.2 percent in 2018, as higher Balkans, and 2 pp in North Macedonia. consumption is undermined by the negative However, the increases are pushing up already contribution of net exports and a deceleration high levels of spending on wages and pensions of investment growth. In Albania, also despite in the region. In addition to rising wages and strong consumption growth, a plunge in employment, solid remittances growth is energy production is projected to slow growth expected to fuel consumption in Kosovo which to 2.9 percent. In Bosnia and Herzegovina, contributes 4.3 pp to growth. In Montenegro, growth is expected to slip to 3.1 percent booming tourism, strong lending to because of lower contributions from net exports households, and higher employment are driving and investment. In Montenegro, growth is private consumption, which is projected to add Figure 2.1. In 2019 growth in the Western Figure 2.2. Higher public spending supported Balkans is projected to decelerate. consumption and investment growth in 2018. Percent Contribution of factors to real GDP growth, percentage points 5 10 8 4 4.0 6 3.3 3 4 3.2 3.1 3.1 3.0 2.9 2 2 0 1.8 1 -2 -4 e e e e e e e 20 8 20 8 20 8 20 8 20 8 20 8 20 8 0 19 19 19 19 19 19 19 1 1 1 1 1 1 1 20 20 20 20 20 20 20 MNE KOS ALB SRB BIH MKD WB6 EU28 ALB BIH KOS MKD MNE SRB WB6 JJ2017 JJ2018 JJ2019e JJConsumption JJInvestment JJNet exports QQReal GDP growth Source: National authorities and World Bank estimates. Source: National statistical office data; World Bank estimates. 2. Growth slows with lower contributions from exports and investments  |  5 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 2.9 pp to growth. Robust employment and Net exports continue to subtract from lending activity also supported Albania’s overall growth, as the region’s trailing productivity consumption, which will add an estimated weighs on opportunities to access larger 2.8 pp to growth. The acceleration in lending markets(Box 2.1). Net exports are subtracting to households, which saw near double-digit the most in Serbia, with a negative contribution growth in Kosovo, Serbia, North Macedonia, of 3.1 pp, due to a 10.2 percent surge in and Montenegro, as well as the high levels of imports and a slow-down in goods exports. In public spending on wages and pensions in the North Macedonia, net exports are not expected region, raise questions about how sustainable to contribute to growth as rising exports the consumption-driven growth is. cannot compensate for the increase in imports. In Bosnia and Herzegovina, as imports rise, Investment is still adding to growth, but the contribution of net exports to growth is more slowly than in 2018. In Montenegro expected to be minimal because exports of investments are projected to fall from their some commodities, such as milk, are losing 2018 contribution of 4.2 percentage points markets. In Montenegro, where investments (pp) to just 1.9 pp because of delays in large and consumption have high import content, public infrastructure projects in the first half of net exports are projected to subtract 1.8 pp the year while private investment is expected to from 2019 growth. In Albania, net exports are remain at a similar level as in 2018. Kosovo will expected to subtract 0.4 pp due to lower energy see a drop in the contribution of investment exports and higher imports. In Kosovo, an to growth from 2.1 to 1.1 percent growth, as increase in exports is overshadowed by import public capital spending is projected to be under- growth, due to a high base. executed. The contribution of investment is projected to remain muted in Bosnia and On the production side, services are driving Herzegovina (0.4 pp) and Albania (0.5 pp), growth in the Western Balkans. Tourism is despite more private investment spurred by again the anchor of Montenegro’s economy, better credit conditions and a pick-up in public- but in the first half of 2019 Albania, Bosnia private partnerships (PPPs) in the latter. The and Herzegovina, and Serbia also enjoyed low contribution in Bosnia and Herzegovina solid growth in tourist arrivals. Tourism also comes from delays in capital spending also supported solid growth in retail trade in plans due to lack of government formation these countries; higher retail trade in North in the Federation. In contrast, investment is Macedonia was mainly driven by increased firming up and is projected to add 1.2 pp to employment and higher wages and pensions. growth in North Macedonia, as both public and Construction continued to be an important private investments started growing, as large driver of growth in several countries, also due to scale public investment projects were resumed high public capital spending. Low precipitation and corporate investment lending intensified. early in the year severely depressed energy In Serbia private and public investments are production in Albania, Montenegro, and Bosnia projected to remain strong in 2019 but a and Herzegovina, which caused industrial reduction in inventories accumulated in the production to fall. Serbia’s industrial output previous year is lowering the contribution to also declined, led by a fall in manufacturing growth. as leading companies in oil derivatives and 6  |  2. Growth slows with lower contributions from exports and investments RISING UNCERTAINTIES Box 2.1. Low productivity limits Western Balkan’s potential output The gap between a country’s actual output and the potential output achieved by other countries with comparable resources (that is, the production frontier) measures its productivity. The way firms and the economy as a whole combine labor and capital inputs into ever more efficient uses (known more simply as productivity) can be measured in several different ways. One approach to estimate productivity is through the stochastic frontier approach (SFA). The production frontier represents the maximum amount of output that can be obtained given the factors of production and the technology available. For a given sample of countries, the SFA makes it possible to estimate each country’s production frontier, recognizing that an economy may be operating below what would be predicted by the production frontier because of the country’s level of development and structural factors. The Western Balkans countries have large productivity gaps.a  The SFA methodology produces three results: (1) As of 2016, the Western Balkans countries had relatively little capital per worker. (2) For a given level of capital per worker, actual output is below what could be achieved. (3) Efficiency gaps across Western Balkan countries are large and comparable in size across the six countries in the region (see Figure B2.1). How can countries in the Western Balkans boost productivity? To boost productivity and reach potential, an acceleration of structural reforms is critical. This includes reinforcing the state institutions that protect the rule of law and private sector competition to fight corruption and level the playing field between firms. And it includes improving public services to boost human capital while preserving macro-fiscal and financial stability. Together, these structural reforms would help unlock stronger, more equitable, and more sustainable growth, ensuring faster convergence with EU income levels (see section 8). Figure B.2.1. Western Balkan countries face large productivity gaps, limiting their income levels Output per worker (thousands of US$ PPP, 2014) 120 100 Denmark Sweden Germany 80 Austria Italy Greece 60 Slovenia Portugal BiH Croatia Serbia Montenegro 40 Albania North Macedonia 20 Armenia Ukraine Moldova 0 0 100 200 300 400 500 Capital per worker (thousands of US$ PPP, 2014) QQPotential output ‹‹Actual output Source: Authors’ calculations. Note: a The analysis builds on the dataset developed by Lusinyan (2018). Data sources: real GDP in billions, constant 2011 international dollars, from the IMF WEO; total capital stock and employment are from PW Table and the WEO. The sample consists of 47 countries in the Europe and Central Asia region for the period 1980–2016, with data availability varying depending on the variable and/or the country. International statistics adopted for the calculation do not cover Kosovo. 2. Growth slows with lower contributions from exports and investments  |  7 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 chemicals overhauled their production processes earlier this year, and FIAT continues to lower its production. In contrast, industrial production went up in North Macedonia, supported by higher energy production and a rise in the manufacturing output primarily of foreign companies. Agricultural production is projected to subtract from growth in Serbia after a strong increase in 2018 but is expected to contribute to growth in North Macedonia. 8  |  2. Growth slows with lower contributions from exports and investments RISING UNCERTAINTIES As employment picked up in 2019, unemployment fell to 3.  historic lows Employment picked up across the Western latter; the employment rate of men was as low Balkans in 2019. In June 2019 employment as 43 percent and of women 13.3 percent. In in the Western Balkans was 2.4 percent higher Bosnia and Herzegovina, where the labor force (y-o-y), adding 149,430 new jobs to the labor again shrank, in 2019 the employment rate rose market compared to the same period a year to 35.5 percent, though that is still the second ago. North Macedonia registered the highest lowest in the region. rate of employment growth–5.2 percent y-o-y–supported by the country’s expanding Owing to higher employment, the employment subsidy scheme. In Albania unemployment rate in the region reached and Bosnia and Herzegovina, most new jobs 15.8 percent in June 2019—the lowest were created in services, as employment in on record. North Macedonia had a drop agriculture continued to slide. Meanwhile, of almost 17 percent y-o-y in the number of supported by growth in tourism and unemployed and in Bosnia and Herzegovina construction, employment also continued unemployment declined by close to 15 percent upward in Montenegro. Serbia, however, saw a y-o-y. In contrast, Montenegro saw a rise in major slowdown in jobs in the second quarter unemployment because its growth model of 2019, after an impressive start of the year. relies mostly on tourism and construction, Notwithstanding the increase in employment which have plateaued. Unemployment rates across the region, only 44 percent of the in all countries in the region reached historical working age population is actually engaged in lows. Albania’s unemployment rate dropped work. Employment rates ran the range from to 11.5 percent and North Macedonia’s to 53.6 percent in Albania to 29.8 percent in 17.5 percent. The decline was largest in Kosovo Kosovo, with stark gender differences in the where, at 25.3 percent, unemployment remains Figure 3.1. Employment picked up and… Figure 3.2. …unemployment fell in all Western Balkans countries. Two-quarter averages, 2017–19 y-o-y; employment growth, Unemployment rate, 15+ years, percent; and 2018–June 2019 percent change, pp 12 20 -1.0 WB6 10 -1.1 15 SRB 8 -0.3 6 10 ALB 4 MNE -0.3 5 2 -1.2 BIH 0 0 -1.7 -2 MKD -5 -4 -0.9 KOS -6 -10 -15 r-16 ep-16 7 -17 8 -18 9 Sep Ma S M ar-1 Sep Mar-1 Sep Mar-1 0 5 10 15 20 25 30 ▬▬ALB ▬▬BIH ▬▬MKD ▬▬MNE ▬▬SRB ▬▬WB6 ▬▬KOS, rhs JJJune 2019 JJ2018 Source: National statistics offices and World Bank staff estimates. Note: June 2019 data refer to 4-quarter moving average. 3. As employment picked up in 2019, unemployment fell to historic lows  |  9 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 much higher. The lowest unemployment rate Long-term unemployment in the Western in the region is still Serbia’s, which stood at Balkans decreased by 1 pp but at 73 percent 10.3 percent in the second quarter of 2019. is still very high; in some countries it has led In Bosnia and Herzegovina, unemployment to discouragement and early withdrawal to went down to 15.7 percent due to increased inactivity. The aggregate numbers mask stark, employment but more significantly because though declining, differences in unemployment of a continued decline in its working age across regions—from 5.9 percent in Elbasan, population. In Montenegro the unemployment Albania, to close to 36 percent in the northeast rate stood at 14.3 percent in June 2019. part of North Macedonia (Box 3.1). Box 3.1. Unemployment declines in the Western Balkans Within the region there are still stark differences in unemployment—from 5.7 percent in the coastal region of Montenegro, to close to 36 percent in the northeast part of North Macedonia. But while regional differences in unemployment are significant in several other Western Balkan countries, in Serbia the disparities are diminishing. Unemployment in the Serbian South-East is now only 1.6 times higher than in the Belgrade area. In Montenegro, however, unemployment is 6.1 times higher in the North than in the Coastal area. Disparities within country have narrowed. A drop in the unemployment rate in the Central region of Montenegro was partly driven by highway construction that absorbed some workers. Yet despite employment opportunities in construction and tourism, and the short commuting areas, internal migration and mobility within Montenegro seem to be low. In North Macedonia, despite a lower unemployment rate nationally, the North-East is still deeply disadvantaged—unemployment there is stubbornly high and apparently entrenched, with no change over the year. Yet employers in North Macedonia as well as across the Western Balkans see labor and skill shortages as an obstacle to expanding their business. Higher within-country and inter-regional mobility could help reduce unemployment in lagging areas of the Western Balkans. Figure B.3.1. Unemployment disparities declined but are still high. Unemployment rates, June 2019 or the latest 36 32 28 24 20 16 12 8 4 0 MKD Pelagonia ALB Shkoder MKD Skopje SRB Vojvodina MNE Coast ALB Elbasan ALB Kukes ALB Korce ALB Berat SRB Belgrade MNE Central ALB Diber ALB Gjirokaster ALB Fier MKD Southeast SRB Sumadija and West MKD East SBR South and East ALB Tirane MKD Vardar ALB Durres ALB Vlore BiH FBiH ALB Lezhe KOS MKD Polog MKD Southwest MNE North MKD Northeast BiH RS Source: National statistical offices. 10  |  3. Fewer jobs were created in 2018 despite strong growth RISING UNCERTAINTIES Figure 3.3. Kosovo’s 2016 labor market gains Figure 3.4. While more people joined the labor were nullified. force and found jobs, progress is slow and uneven. Percent of population aged 15+ Percent of population aged 15+ 35 100 90 30 80 47.6 47.5 25 70 20 60 50 8.2 7.7 15 40 10 30 44.2 44.8 20 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 5 2018 2018 2018 2018 2018 2018 2018 10 0 0 KOS MKD BIH MNE ALB SRB KOS MKD BIH MNE ALB SRB WB6 JJUnemployment rate (2016) ▬▬Unemployment rate (2019) JJEmployed JJUnemployed JJInactive QQLong term unemployment Source: National statistics offices and World Bank staff estimates. Note: June 2019 data refer to 4-quarter moving average. Over the year, some 43,100 young people a proportional rise in youth employment. found jobs in the Western Balkans, with Overall, the still high youth employment rate in Albania accounting for half of these. Youth the Western Balkans not only lowers the labor unemployment in the region has fallen supply but likely undermines the future stock 5 pp since June 2018, but at 30.6 percent, of human capital. Despite recent stagnation it is still stubbornly high. The lowest youth in emigration rates in several Western Balkan unemployment rate was in Montenegro countries, young people are still the most at 20.7 percent, followed by Albania and numerous among those emigrating. Serbia, both below 25 percent. Moreover, further declines in youth unemployment in Labor force participation has improved Montenegro are expected as the new labor but current levels continue to depress law, designed to make the labor market more employment and country differences remain flexible, could speed up employment of youth marked. Sustained growth in the region has and women and shorten job searches. In not only supported job creation but also Kosovo, authorities must deal with a youth attracted people back into the labor force. unemployment rate of more than 49 percent, a In June 2019 the labor force participation problem that is becoming endemic. To this end, rate averaged 52.1 percent—up 0.4 pp since youth employment programs—combinations June 2018, with the largest gain, 1.6 pp, in of employment subsidies and occupational Montenegro. Labor force participation reached and training programs—could help put youth 60.6 percent in Albania—a new record in to work and discourage their emigration. the region. For Serbia, lower labor force Such programs would also help address youth participation in the second quarter of 2019 joblessness in North Macedonia, which has seen was coupled with a 0.5 percent decline in the the largest decline in the youth unemployment working-age population; the country is aging rate (a drop by close to 13 pp to 37 percent, and facing emigration. In Kosovo and Bosnia from the peak in Q3 2017), but without and Herzegovina participation rates have 3. Fewer jobs were created in 2018 despite strong growth  |  11 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Figure 3.5. In some countries, inactivity is Figure 3.6. The female–male labor high and heading up. participation gap narrowed to below 18 percentage points. Inactivity rate, 15+ years, percent, and 2018–2019 change, pp Labor force participation, percent, June or latest 2019 -0.1 80 WB6 -0.2 70 SRB 60 -0.4 ALB 50 -0.8 MNE 40 0.1 BIH 30 -0.1 20 MKD 0.3 10 Jun-18 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 Jun-19 KOS 2015 2015 2015 2015 2015 2015 0 20 25 30 35 40 45 50 55 60 ALB SRB MNE MKD BIH KOS JJJune 2019 JJ2018 QQFemale LFP QQMale LFP Source: National statistics offices and World Bank staff estimates. stagnated at or below 42 percent. At a regional Wages are increasing throughout the region, level, improvements in labor force participation partly due to hikes in the minimum wage; have been driven by more female entrants any further minimum wage increases should into the labor market. In Albania the female track productivity growth. In Albania, since participation rate (ages 15–64) shot up above 2017 the minimum wage has gone up by over 53 percent, narrowing the gender gap to just 18 percent. This especially affected wages in 15 pp. Serbia and Montenegro also hold female agriculture and construction, which are labor- participation rates above the regional median intensive. In the first half of 2019, average real of 47 percent. Over the year the gender gap in wages rose by 3.3 percent, led by trade, transport the Western Balkans declined by over 1 pp, to and tourism. Since 2017 North Macedonia and 17.7 percent, but at 39 pp the gender gap in Serbia have also seen the minimum wage go up. Kosovo is a stark outlier. In North Macedonia in the first half of 2019, average real net wages increased by more than Despite improvements, years of growth, 2 percent y-o-y because of rises in the minimum and state aid programs to support job wage in July 2018 and April 2019 and raises for creation, in the Western Balkans inactivity public servants from early 2019. The highest is still 48 percent. In Kosovo and Bosnia and wage increases in North Macedonia were Herzegovina inactivity increased by June 2019 in health, education, and social protection, (on a four-quarter basis), suggesting that exit transport, construction, and agriculture. The from unemployment into inactivity was higher combination of continuing wage growth, than entry into employment. However, in particularly in labor-intensive industries, and other countries growth supported job creation a decline in labor productivity is jeopardizing and encouraged labor force participation. High the country’s competitiveness (Figure 3.8). In working-age inactivity also requires higher September, the government approved another productivity of those employed to maintain the program to boost formalization of wages by living standard for the larger group. subsidizing social security contributions. In Serbia, in the first half of 2019 the average 12  |  3. Fewer jobs were created in 2018 despite strong growth RISING UNCERTAINTIES Figure 3.7. While across the region minimum Figure 3.8. ...in several countries productivity wages have gone up recently... has not. Minimum to national average wage ratio, percent Average productivity and real gross wage growth, 2015–18, percent 55 3.0 2.5 40 2.0 45 1.5 40 1.0 0.5 35 0 30 -0.5 25 -1.0 KOS MNE BIH MKD ALB SRB ALB BIH MNE MKD SRB JJ2017 JJSept. 2019 Total productivity Source: National statistics offices and World Bank staff estimates. Source: World Development Indicators, World Bank. Note: Productivity is measured as GDP per capita in constant 2011 US$ PPP; gross wages are deflated by the CPI. wage increased most—by 7.2 percent y-o-y in poverty rate to an estimated of 21.6 percent.1 real terms, as private sector wages rose because Still, poverty in the Western Balkans remains of skills shortages in services. Even though as higher than Central and Eastern Europe or recently as January of 2019 the minimum wage the European Union more broadly. Social went up 8.6 percent, the government agreed to assistance reform in North Macedonia should raise it again by 11 percent. Minimum wages help reduce poverty; the government replaced are highest in Serbia and Albania; any further the fragmented system of social benefits increases should track productivity growth to with a more unified Guaranteed Minimum avoid undermining cost competitiveness, which Allowance, for which the benefit is higher, and is crucial for attracting foreign investment. In more people are eligible. The government has fact in Serbia, North Macedonia, and Albania, also increased amounts and coverage of the growth in real wages was misaligned given child and educational allowances; introduced meager productivity growth, or a decline in the means-testing for the parental allowance, which case of Serbia. In Montenegro, the minimum should reduce inclusion of medium- and high- wage went up 15 percent in July, though the income families; and introduced a social safety employer health contribution rate was reduced net for those older than 65. from 4.3 to 2.3 percent to prevent a rise in unit labor costs and thus a loss in competitiveness. Growth in disposable incomes and low inflation are helping reduce poverty. In 2018, roughly 114,000 people in Albania, Kosovo, Montenegro, North Macedonia, and Serbia were lifted out of poverty (living on under $5.5/day in 2011 PPP) from a year earlier, bringing the region’s average weighted 1 Poverty figures reflect the upper-middle-income-country standardized benchmark of living on less than US$5.50 a day in 2011 PPP terms. 3. Fewer jobs were created in 2018 despite strong growth  |  13 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Rising uncertainties call for rapid improvement in public 4.  finances In all countries in the Western Balkans a solid increase in revenues, thanks to strong except Kosovo and Montenegro, fiscal economic activity, have reduced the fiscal deficits are projected to go up in 2019. The deficit by 0.9 pp. But at 3.2 percent of GDP, average unweighted fiscal deficit is expected Montenegro still has the largest fiscal deficit in to rise from 1.2 percent of GDP in 2018 to the region. 2 percent in 2019 (Figure 4.1). The largest increase is expected in Bosnia and Herzegovina Revenues are rising in most countries, but as a result of implementation of a new law on not enough to offset rising government demobilized veterans in the Federation and spending  (Figure 4.2). Cyclical factors higher public wages in Republika Srpska. The resulting from stronger economic growth, fiscal deficit in Albania is projected to widen combined with improved debt collection, were to 2.2 percent of GDP in 2019 as slower than largely responsible for strong revenue growth in expected economic growth weighs on revenues, Montenegro and Kosovo. Although Kosovo’s but also because the government is paying off revenues-to-GDP ratio has improved, at VAT arrears to the private sector. In North 27.4 percent it is still the lowest in the Western Macedonia, a surge in current spending has Balkans. For North Macedonia, revenues are driven the deficit from 1.1 percent of GDP projected to increase by 1.6 pp, to 32 percent of in 2018 to an estimated 2.4 percent for 2019, GDP, due to an increase in pension contribution and Serbia’s fiscal position is expected to turn rates; a return to progressive income taxation; to deficit due to intensified capital spending. higher tax rates for capital gains; higher tobacco Kosovo’s fiscal deficit is projected to be largely excises; and closing income tax exemption unchanged at just below 3 percent of GDP. In loopholes. In contrast, despite growing in Montenegro, fiscal consolidation efforts and nominal terms, revenues in Albania, Serbia, Figure 4.1. The fiscal deficit is projected Figure 4.2. …higher revenues are offset by a to go up in all countries except Kosovo and surge in spending. Montenegro… Fiscal deficits, pp of GDP Contribution to change in the fiscal deficit, 2019e, percent of GDP 6 3 ↑Reduced revenues, increased spending 5 4 2 3 1 2 1 0 0 -1 -1 -2 ↓Increased revenues, reduced spending -3 -2 MNE KOS MKD ALB BIH SRB WB6 BIH KOS SRB ALB MKD MNE WB6 JJ2017 JJ2018 JJ2019e JJExpenditure JJRevenue QQChange in fiscal deficit Source: National statistics offices and World Bank staff estimates. Source: National statistics offices and World Bank staff estimates. 14  |  4. Rising uncertainties call for rapid improvement in public finances RISING UNCERTAINTIES and Bosnia and Herzegovina are projected to is on account of rising pensions, public wages, decline as a share of GDP: In Albania, lower health spending, and subsidies, as well as GDP growth and repayment of VAT-refund transfers to local governments and the clearing arrears have cut into revenue growth, although of arrears. In Kosovo, new laws on public revenues did go up, supported by a rise in salaries and social transfers for specific groups personal income tax and social contribution heighten the pressures on spending in 2020. receipts as formal employment increased, Moreover, war veteran benefits are both costly informality was reduced, and wages went up. and untargeted. Serbia is using fiscal space More formal employment and rising wages also created by its solid fiscal performance in recent supported revenue growth in Serbia, assisted by years to unwind pension and public wages cuts higher VAT receipts from imports. In Bosnia and to increase capital spending (Figure 4.4). and Herzegovina, indirect taxes contributed to This is reflected in an increase of 0.6 pp in marginal nominal growth in revenues. government spending. Although Montenegro is expected to reduce government spending as Buoyant cyclical revenues stimulated a percent of GDP, current spending has not national appetite for spending. The surge been fully contained as wages grew in nominal in government spending has been particularly terms due to delays in carrying out the public pronounced in North Macedonia, where it administration optimization plan. is projected to rise by 2.8 pp, and in Bosnia and Herzegovina, where the expected rise Fiscal rules can anchor fiscal sustainability. is 1.9 pp (Figure 4.3). While the latter’s Except for North Macedonia, all Western heightened spending will be entirely driven by Balkan countries have fiscal rules on debt current spending on war veteran benefits and and deficit limits (Box 4.1). Albania has been by higher public wages, in North Macedonia complying with its main rule—keeping its both capital and current spending are projected public debt-to-GDP ratio declining until it to contribute to spending growth. The expected falls below 45 percent. However, the country’s current spending increase in North Macedonia strict definition of public debt has incentivized Figure 4.3. Social benefits are driving Figure 4.4. …and together with public wages increased government spending… account for over half of total spending. Contribution to change in public spending, 2019e, pp of GDP Composition of estimated public spending, 2018 and 2019e, percent of GDP 3 50 40 2 30 1 20 0 10 2019e 2019e 2019e 2019e 2019e 2019e 2019e 2018 2018 2018 2018 2018 2018 2018 -1 0 BIH KOS SRB ALB MNE MKD WB6 MNE BIH SRB MKD KOS ALB WB6 JJWage bill JJSocial benefits JJCapital expenditures QQTotal expenditures JJWage bill JJSocial benefits JJCapital expenditures QQTotal expenditures Source: National statistics offices and World Bank staff estimates. Source: National statistics offices and World Bank staff estimates. 4. Rising uncertainties call for rapid improvement in public finances  |  15 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 the reliance on non-marketable liabilities two entities, with the ratio of debt-to-GDP in (e.g., public-private partnerships (PPPs) and Republika Srpska now significantly higher than arrears). Bosnia and Herzegovina and Kosovo for either the BiH Institutions or the FBiH are complying with their debt and deficit rules, and above its debt limit (60 percent of GDP). but Kosovo’s new law on public salaries calls for Serbia is complying with its formula-based more spending on wages, which, could breach deficit rule, but Montenegro did not manage the fiscal rule on wage growth, if employment to keep its deficit below the 3 percent of GDP and allowances are not contained through the defined by its fiscal rule, and its debt-to-GDP 2020 budget. Furthermore, in Bosnia and ratio is rising to new highs. Herzegovina, indebtedness varies between the Box 4.1. Fiscal Rules in the Western Balkans: What Does the Public Say? Fiscal rules have become an important subject of policy debate in the Western Balkans, but the question remains what rules should govern fiscal policy in the Western Balkans and how can they be made more effective? The rise in public debt following the global financial crisis focused attention on strategies for restoring sound public finances, while plans to join the European Union (EU) mean that the countries will need to be in a position to adopt and comply with the EU’s fiscal rules. Four of the countries in the region—Albania, Montenegro, North Macedonia, and Serbia— are official candidates to join the European Union (EU). The other two—Bosnia and Herzegovina and Kosovo—are “potential candidates.” When the countries do join the EU, they will be required to adopt and comply with the EU’s fiscal rules. In the meantime, they need to consider their own approaches and ensure that they work. Fiscal rules are long-term numerical constraints on fiscal aggregates that aim to improve fiscal discipline by requiring governments to declare and commit to a monitorable fiscal policy and strategy. Often, a driving force behind fiscal rules is the wish to make fiscal policies more predictable and credible by establishing rules and procedures the government must follow in the design and implementation of fiscal policy, and by setting up transparent mechanisms by which others can judge if the government is complying with the established goals and priorities. If well designed and implemented, fiscal rules can promote policy credibility, enhance investor confidence, help maintain macroeconomic stability, maintain or help restore fiscal sustainability, contribute to sustained growth and improve transparency and intergenerational efficiency. Despite having fiscal rules in most Western Balkan countries, they have often not been rigorously enforced. National fiscal rules are more likely to be rigorously enforced when noncompliance is politically embarrassing. This in turn is more likely if the rules are reasonably well understood and enjoy cross-party political support. To shed some light on the extent of public awareness of fiscal rules and fiscal watchdogs in the six Western Balkan countries, in December 2018 the World Bank conducted an online survey among various targeted stakeholders (government, journalists, academics, bankers, think-tank analysts, and others interested in public finances) on the subject. Results show some understanding of fiscal rules in the Western Balkans  (Figure B.4.1). Among the presumably relatively well-informed respondents, a large majority said they knew what fiscal rules were, and many had an understanding consistent with the definition of a fiscal rule—a long-term numerical constraint on debt, deficit, or other fiscal aggregate. But there are also some differences: in 16  |  4. Rising uncertainties call for rapid improvement in public finances RISING UNCERTAINTIES Box 4.1 continued particular, some respondents could not distinguish fiscal rules from annual budget limits or medium- term fiscal targets. Not all respondents knew exactly what rules were in force in their own country. Around 43 percent of respondents believe rules are complied with; however, over half of them believe rules are circumvented. Around 39 percent of respondents think the rules are not complied with, and almost one-fifth could not provide a response, suggesting they are not clear given the rules complexities or could not find the monitoring body reports. The respondents believe rules are not complied with due to high public spending on the wage bill and other current spending, tax exemptions and low collection, as well as excessive capital spending. However, over half of respondents believe rules are circumvented (Figure B.4.2). Figure B.4.1. There is some understanding Figure B.4.2. …but not so much of fiscal rules among well-informed survey understanding as to whether fiscal rules are participants… complied with. What fiscal rules are in place in your country? Why the fiscal rule is not complied with? Percent Yes, it is a 70 quantitative rule that prescribes limits on 60 the fiscal deficit, debt or expenditure 50 ceiling set in the law Skipped, 31 or constitution, 85 40 30 20 10 0 No, I don't There is a high A lot of tax Excessive The fiscal rule is Other understand, 20 public spending exemptions capital being on the public- and low tax spending. circumvented by Yes, it is an annual sector wage bill collection. delaying fiscal deficit and other current infrastructure embedded in the spending maintenance, annual budget law, 13 categories. building of Yes, all of the arrears or above, 40 Yes, it is the medium-term fiscal interference in deficit and the debt target, 8 statistics. Source: World Bank 2019. Source: World Bank 2019. Figure B.4.3. Public Support for Fiscal Rules. Do you believe that the existing fiscal rules in your country contribute to more prudent budgeting, improve government fiscal performance and accountability? Percent 80 70 60 50 40 30 20 10 0 Yes No References: World Bank. 2019. ”Fiscal Rules for the Western Balkans”. World Bank, Washington DC. 4. Rising uncertainties call for rapid improvement in public finances  |  17 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Figure 4.5. Public and publicly guaranteed Figure 4.6. …and external PPG debt is debt (PPG) rises in Montenegro, North expected to go up in Montenegro, Serbia, and Macedonia, and Kosovo… North Macedonia. PPG debt, percent of GDP External PPG debt as a percent of GDP, 2019e 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 MNE ALB SRB MKD BIH KOS WB6 MNE SRB MKD ALB BIH KOS WB6 JJ2019e ▬▬2018 QQ2007 JJ2019e ▬▬2018 QQ2007 Source: National statistics offices and World Bank staff estimates. Source: National statistics offices and World Bank staff estimates. Still-high public debt in some countries but also because public investment is due to coupled with fiscal risks and depleted accelerate. Montenegro’s PPG debt is projected fiscal buffers make the Western Balkan to reach a high of 83 percent of GDP by countries highly vulnerable to rising external yearend following the government’s issuance uncertainties. Successful fiscal consolidation of €500 million in Eurobonds to service debt programs and more prudent fiscal management due in 2020, and an expected intensification of have allowed Serbia to reduce PPG debt as a highway construction later this year. share of GDP to 52.1 percent and Albania to reduce its PPG debt to 68.4 percent The fact that current market conditions (Figure 4.5). Albania achieved its reduction allow for cheap external financing is an by careful spending, clearance of arrears, and opportunity if it is accompanied by prudent currency appreciation; but mounting off- fiscal management ( Box 4.2). The window of balance risks, including from a rapid buildup opportunity should be used to either refinance in PPPs, are now a major concern. In Bosnia current external debt at a lower rate and extend and Herzegovina, PPG debt has been stable maturities or build up foreign exchange reserves in nominal terms and has declined a bit as a as a buffer against liquidity shocks. However, percentage of GDP; much of its debt is long- because uncertainties in global markets are term, at favorable rates. However, the country rising, such conditions may be short lived. must also deal with fiscal risks emanating from Furthermore, cheap external financing should its highly leveraged state-owned enterprises not be used to delay much-needed reforms. (SOEs) and from sizable expenditure arrears. By the end of 2019, the recent issuance Kosovo’s PPG debt is projected to go up of 500 million in Eurobonds is projected slightly, to 17.7 percent, as capital investments push Montenegro’s external PPG debt to an (mainly financed by privatization proceeds) are estimated 72 percent of GDP (Figure 4.6). In expected to pick up later in the year. North July, Serbia issued its first Eurobond in six years Macedonia will see an increase in PPG debt, and the first denominated in euros, raising due mainly to higher government borrowing, €1 billion at a rate of 1.6 percent with a 10- 18  |  4. Rising uncertainties call for rapid improvement in public finances RISING UNCERTAINTIES Box 4.2. Recent Eurobond Developments in the Western Balkans. In 2018 and the first half of 2019, with continued favorable conditions on the Eurobond market, in a range of landmark deals countries in the Western Balkans have successfully accessed international markets. Public bond issues on the Euro market by the governments of Albania, Montenegro, North Macedonia, and Serbia have all been successful—as is also true for issues in the Europe and Central Asia region and emerging markets globally (Table B.4.1). Table B.4.1. Recent Eurobond issuances in the Western Balkans. Issuer Pricing date Tranche Face Value Currency Coupon Maturity (bn USD) North Macedonia 1/11/2018 0.6 Euro 2.8 7 Montenegro 4/12/2018 0.6 Euro 3.4 7 Albania 10/2/2018 0.6 Euro 3.5 7 Serbia 6/19/2019 1.1 Euro 1.5 10 Montenegro 9/26/2019 0.6 Euro 2.6 10 Source: Dealogic database. With yields low in advanced countries, investors are turning to emerging market debt as an alternative asset class. Policymakers in the advanced economies have actively sought to lower interest rates in the hope of reviving moribund trends in the real economy, but confronted by considerable economic uncertainty,1 global investors have shifted into the safer fixed-income assets of advanced economies, thus accepting low yields on debt securities—yields are now negative on more than $16 trillion. Those investors in search of higher yields are now turning to emerging-market debt as an alternative.2 For the Western Balkans, the continued benign conditions for access to international capital markets could be an opportunity. Governments and large corporations can selectively use external borrowing to raise financing for carefully identified high-payoff investments that in the short term cannot be funded out of revenues. This may also be an opportunity for them to refinance existing external debt at a lower rate and extend maturities while bolstering foreign exchange reserves. By deepening their presence in Eurobond markets, extending their yield curve, and building a track record of successful issues, borrowers can also hope to access international markets in the future on more favorable terms. As governments and large corporations turn to foreign financing, to the extent that there is crowding out, it may also free the domestic financial sector to serve other private sector players. Exposure to international markets can also discipline domestic reform efforts. However, continued fiscal discipline is crucial. Even though access to Eurobond markets comes with greater market scrutiny, there is nevertheless the risk that countries may take on excessive debt and delay necessary fiscal consolidation. They may then be caught off-guard if the lending environment suddenly changes, debt servicing costs shoot up, and markets refuse refinancing. For example, a major international default could lead investors to re-evaluate default risks and flee emerging markets. It is therefore vital that international markets are accessed responsibly, with careful weighing of costs as well as benefits. 1 Numerous factors are weighing on the global economy, among them international trade tensions, the risk of a disorderly Brexit, and continued weakness in in investment and productivity growth. 2 For European insurance companies, the challenge of low yields on traditional debt investments is compounded by the tighter regulatory requirements of the Solvency II regime now coming into force, raising the cost of doing business. Finally, frontier-market bonds are increasingly integrated into bond indexes, increasing demand from institutional investors who track those indexes. 4. Rising uncertainties call for rapid improvement in public finances  |  19 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 year maturity; it used the proceeds to buy back external PPG debt is expected to hold at US$-denominated Eurobonds that had been about 6 percent of GDP because execution of issued earlier at a higher rate. Improvements capital projects financed by IFI loans has been in the execution of foreign-financed capital minimal. On the other hand, external PPG projects have also pushed up Serbia’s external debt as a percent of GDP is expected to decline PPG debt to an estimated 38.1 percent of slightly in Bosnia and Herzegovina and Albania. GDP. North Macedonia’s intensified borrowing Currency appreciation and more careful fiscal and the acceleration of foreign-financed public management are expected to bring Albania’s investments are projected to push external external PPG debt down to 32.4 percent of PPG debt above 35 percent of GDP. Kosovo’s GDP. 20  |  4. Rising uncertainties call for rapid improvement in public finances RISING UNCERTAINTIES 5.  Positive credit growth is driven by household lending As global growth and prices slow, inflation Monetary policy has been eased to in the region has declined. Since the end of support credit growth. In Serbia and North 2018 inflation dynamics have softened, thanks Macedonia, policy interest rates were reduced, to low inflation in trading partners and lighter and Serbia intervened in the foreign exchange domestic demand pressures (Figure 5.1). In market to ease short-term currency fluctuations June 2019 inflation in the Western Balkans and related impacts on inflation (Figures averaged 1.17 percent, down from 2.1 percent 5.3 and 5.4). In Serbia, as inflation hovered (year-on-year). With generally lower global in the lower half of the inflation tolerance prices for key commodities, inflation dynamics band, in August the policy rate was brought have largely reflected a decline in imported down to 2.5 percent. To mitigate excessive inflation, augmented by the pass-through short-term volatility of the dinar against the effects of appreciating currencies in countries euro, the National Bank of Serbia intervened with floating exchange rate regimes. Low and in the foreign exchange market. In Albania, stable core inflation suggests that long-term lower-than expected inflation associated with inflationary pressures remain contained (Figure exchange rate appreciation has prompted the 5.2). Inflation was highest in Kosovo, driven by central bank to hold the policy rate at 1 percent a hike in food prices from its imposition of a since June 2018; the bank has announced that 100 percent tariff on imports from Serbia. In it will start normalizing monetary policy in the Bosnia and Herzegovina, inflation stabilized second half of 2020. In North Macedonia, at throughout the first part of 2019 as transport the beginning of 2019 the central bank lowered prices softened. In Montenegro inflation fell the key interest rate by 25 bps, to a historic to 0.5 percent, thanks to falling prices for low of 2.25 percent. With monetary policy clothing, transportation, alcohol, and tobacco. accommodative for the past year, the pass Figure 5.1. Inflation is trending down, tracking Figure 5.2. Core inflation remains subdued. global food and oil prices. Headline CPI inflation, y-o-y percent Core Inflation, y-o-y, percent 5 6 4 4 3 2 2 1 0 0 -2 -1 -4 -2 -3 6 -16 -16 -16 -17 -17 -17 -18 -18 -18 -19 -19 -17 y-17 -17 -18 y-18 -18 -19 y-19 Jan May Sep Jan May Sep Jan May Sep Jan May Jan Ma Sep Jan Ma Sep Jan Ma ▬▬ALB ▬▬BIH ▬▬KOS ▬▬MKD ▬▬MNE ▬▬SRB ▬▬WB6 ▬▬ALB ▬▬BIH ▬▬KOS ▬▬MKD ▬▬MNE ▬▬SRB ▬▬WB6 Source: Central Banks and World Bank estimates. Note: Food and energy prices are included in headline but not core price indexes. 5. Positive credit growth is driven by household lending  |  21 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Figure 5.3. Central banks in North Macedonia Figure 5.4. …and Serbia intervened in foreign and Serbia further lowered policy rates… exchange markets. Official policy interest rates, percent Exchange rate changes, 2014–19, percent 5 7 6 5 4 4 3 2 3 1 0 2 -1 -2 -3 1 -4 -5 -6 0 -7 -16 -16 v-16 -17 -17 -18 18 -18 -14 un-15 ec-15 un-16 ec-16 un-17 ec-17 un-18 ec-18 un-19 Jan Jun No Apr Sep Feb Jul- Dec Dec J D J D J D J D J ▬▬ALB ▬▬MKD ▬▬SRB ▬▬Eurozone ▬▬ALB ▬▬MKD ▬▬SRB Source: Central bank and ECB estimates. Source: Central bank estimates. Note: Increase indicates depreciation. Figure 5.5. Credit outstanding continued to be Figure 5.6. Credit to households grew positive throughout the region. consistently, but not credit to firms. Change in nonfinancial private sector credit outstanding, percent Change in credit outstanding, percent y-o-y in July 2019 y-o-y 12 12 10 10 8 8 6 4 6 2 4 0 2 -2 -4 0 -16 -16 v-16 -17 ep-17 -18 18 -18 ay-19 Jan Jun No Apr S Feb Jul- Dec M ALB BIH KOS MKD MNE SRB ▬▬ALB ▬▬BIH ▬▬MKD ▬▬MNE ▬▬SRB ▬▬KOS JJFirms JJHouseholds Source: IMF IFS, Central banks. Source: Central banks. Note: Consistent data on private sector credit growth in Albania, Bosnia and Herzegovina, Republic of North Macedonia, and Serbia are from IMF International Financial Statistics (IFS). Data on household and corporate credit are from national central banks. Other depository corporations surveyed are expressed in local currency (euros for Kosovo). Data for Montenegro are based on central bank statistics for credit to residents but not to governments and financial institutions. through of the lower policy rate to commercial strongest growth of credit to the private sector, banks deposit and lending rates has intensified reaching about 10.5 percent in June (y-o-y) in North Macedonia, and credit growth appears as credit standards eased; followed by North to be reviving. Macedonia and Serbia at about 8 percent each (Figure 5.5) as credit demand grew. At In all Western Balkan countries, credit 5–7 percent, lending was also robust in Bosnia growth2 has been positive, but in most, and Herzegovina and Montenegro. In Albania lending to households is growing faster credit growth has been recovering (3 percent) than lending to businesses. Kosovo saw the as demand gradually improves, but credit conditions have not caught up with demand.3 2 Credit here refers to the stock of nonfinancial private sector credit outstanding. Its growth reflects changes in both new credit (positive effect) and NPL write-offs (negative). 3 CESEE Bank Lending Survey for H1 2019. 22  |  5. Positive credit growth is driven by household lending RISING UNCERTAINTIES Figure 5.7. Nonperforming loans are declining. Figure 5.8. Banks are adequately capitalized. NPLs as percent of total loans Percent and percentage point change 30 25 4 25 3 20 2 20 15 1 15 10 0 10 -1 5 5 -2 0 0 -3 ALB SRB BIH MNE MKD KOS SRB KOS ALB MNE MKD BIH JJMar-18 JJMar-19 QQPeak since 2008 ‹‹Pre-crisis level (end 2007) JJMar-18 JJMar-19 QQAverage (2006–08) ‹‹Change since Dec 2014, rhs Source: IMF FSIs, National central banks. Source: IMF FSIs, National central banks. Region-wide, lending to households—mainly Republika Srpska, and Kosovo. In July the Bank consumer loans—grew consistently, but credit of Albania adopted a framework for voluntary to firms has been subdued, in part due to the bank out-of-court restructuring of large limited range of financing instruments available NPLs. Montenegro has expanded coverage of (Figure 5.6). According to a recent survey by the credit registry to enhance the capacity of the European Commission,4 an average of lenders to assess credit risk and has amended 15 percent of the firms in the region consider its credit risk management regulation to align access to finance to be their most important it with European Banking Authority standards. problem, more than double the 7 percent in the EU28. The World Bank, with support Western Balkans are well-capitalized and from authorities in the region, has developed a have benefited from consolidation. As practical guide for capital market development of March, bank capital adequacy averaged in small economies (Box 5.1). 18 percent (Figure 5.8), though profitability, as measured by the return on assets, remains With NPLs decreasing in all countries, credit low at 1.3 percent. As for consolidation, in is gradually becoming less constrained. As of Albania, since Fall 2018 the number of banks March 2019, the regional NPL average was has dropped from 16 to 12 due to mergers and 6.6 percent of total loans, down 2 pp from the license removal of a small non-operational bank, end of 2017 (Figure 5.7). In Albania, though while in Montenegro two undercapitalized by June NPLs had steadily declined from over banks have been liquidated. However, the 20 to 11.2 percent, they are still the highest in vulnerabilities of domestic and state-owned the region; at 2.5 percent, Kosovo’s NPLs are banks still raise concerns about asset quality the lowest. Recent reforms have helped reduce and the health of specific banks. Considering NPLs considerably as Albania, Montenegro, the size of Western Balkan economies and and Serbia continue to write off and sell old their financial sectors, there is room for further NPLs. New insolvency laws are in place in consolidation, entry of reputable players, and Albania, the Bosnia and Herzegovina entity gains in banking efficiency. 4 European Commission, Survey on the Access to Finance of Enterprises – Analytical Report, 2018. 5. Positive credit growth is driven by household lending  |  23 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Box 5.1. The Assessment Framework on Preconditions and Capital Market Developmenta When small economies consider developing capital markets, an overarching principle is that such markets should be adapted to the requirements of the domestic economy, companies, and investors based on current levels of activity and the needs of market participants. There is no one-size-fits-all solution; the roadmap for development will be based on the unique circumstances of the specific economy. Markets have a certain structure for a variety of reasons, among them the macroeconomic environment, tax environment, and, more often than not, the political and economic path that led to a current makeup of the corporate economy. There is, however, a general sequence that can be followed. Figure B.5.1. Preconditions and Capital Markets Assessment Framework. When considering the potential for developing capital markets, first, macro-fundamental preconditions should be assessed  (Figure B.5.1). Otherwise, it will be extremely difficult to build deep, liquid, and orderly securities markets in the medium term. Among factors to be considered are the stability of the macroeconomic environment, gross domestic savings, inflation, and interest rates. The soundness of the banking sector should also be considered. If the preconditions are inadequate, policymakers and regulators must focus on making progress in establishing a suitably conducive macroeconomic environment for a capital market. Once macroeconomic fundamentals have been 24  |  5. Positive credit growth is driven by household lending RISING UNCERTAINTIES Box 5.1 continued assessed, the condition of supportive institutions and the broader legal and institutional environment should be evaluated. Characteristics of a supportive environment for issuers and investors would be efficient contract enforcement, procedures for incorporation and insolvency, accounting and auditing rules, fair competition, and tax policies. If the macroeconomic fundamentals are in place, such institutional and regulatory factors can be addressed in conjunction with other aspects of the capital market. With basic preconditions in place and trends generally positive, an analysis of supply and demand is recommended to identify causes of underdevelopment. On the demand side, to achieve depth and liquidity capital markets depend on a diversified investor base with varying investment time horizons and differing market views. An assessment of the investor base covering types and size of domestic institutional investors, retail investors, and foreign investors is also needed to identify weaknesses to be addressed to grow the investor base. In addition to demand for capital market products, it is important to explore the supply side— the pipeline of potential issuers. A supply-side assessment should start with analysis of financial and corporate issuers: the magnitude of the equity and corporate debt markets and the number of potential issuers. If the pipeline of corporate issuers is limited, it should be ascertained whether this is due to the structure of the corporate sector (i.e., size and number of companies) or to technical issues that discourage companies from issuing stocks and bonds. Structural constraints can be addressed over time by first facilitating development of the private sector, and of private equity and venture capital to incubate firms for later listing. In parallel, reform efforts should target the development of money and government bond markets, which can occur regardless of the level of capital market development in a country and is typically viewed as the first step in capital market development. If conditions on both supply and demand sides are conducive, further analysis could assess specific market segments to get a clearer picture of cross-cutting issues and guide the design of reforms. The Assessment Framework contains building blocks on all market segments with indicative topics for discussion as part of a diagnostic: money, government bond, non-government bond, equity and derivatives markets; and aspects of the enabling environment: laws, regulation and supervision, market infrastructure, the investor base, and regional integration. a http://documents.worldbank.org/curated/en/397831562046607724/Practical-Guide-on-the-Potential-of-Capital-Markets-Development-in- Small-Economies. 5. Positive credit growth is driven by household lending  |  25 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 6.  Exports slow amid rising international trade tensions In 2019 the current account deficit (CAD) Imports are rising mainly due to large is expected to go up in all Western Balkan infrastructure investment projects that countries, largely due to a pick-up in have pushed up demand for capital and imports and a slow-down in export growth. intermediate goods and raw materials. Serbia experienced by far the steepest rise: its Imports are expected to rise in response to CAD rose by 1.5 pp of GDP. The leading cause the needs of public investments in Bosnia and was the country’s deteriorating trade deficit as Herzegovina and Kosovo, and of the needs of imports rose by 2.5 pp and the net services infrastructure projects and tourism investments surplus dropped by 1.5 pp. The CAD increase in Montenegro (Figure 6.2). In North in the other four countries ranged from 0.2 Macedonia, rising imports of intermediate to 0.4 pp and was largely related to rising goods are a result of the high import content imports, with exports slowing as a percent of of FDI operations in the country, coupled GDP. Montenegro’s CAD is projected to hit with increased investment activity and road 17.4 percent in 2019 due to the high import- construction. In most countries in the region dependency of its investments. Montenegro growing consumption has also stimulated had solid growth of exports in the first half imports of consumption goods and worsened of 2019 led by tourism, but since the import most trade deficits. volume is double the export volume, the trade deficit increased despite somewhat lower Export growth in the Western Balkans is import growth. Thus, the regional CAD is projected to slow by 1 percent in 2019, expected to widen from 5.4 to 6.3 percent of mainly because of falling demand from EU GDP (Figure 6.1).  nd deteriorating trade relations trade partners a among some CEFTA countries after Kosovo Figure 6.1. By yearend-2019, the CAD is Figure 6.2. …mainly because of rising imports expected to widen slightly for the region… for infrastructure projects. CAD, percent of GDP, 2012–19e Estimated sources of CAD changes, percentage points of GDP 2012 2013 2014 2015 2016 2017 2018 2019e 6 ↑Reduced exports, increased imports 0 5 4 3 -5 2 1 0 -10 -1 -2 -15 -3 -4 ↓Increased exports, reduced imports -5 -20 KOS MNE BIH SRB MKD ALB ▬▬ALB ▬▬BIH ▬▬KOS ▬▬MKD ▬▬MNE ▬▬SRB JJGoods exports JJGoods imports JJNet services exports ▬▬WB6 JJRemittances JJOthers QQChange in CA deficit Source: National authorities and World Bank staff calculations. 26  |  6. Exports slow amid rising international trade tensions RISING UNCERTAINTIES in November 2018 imposed a 100 percent However, an increase in net services exports is tariff on the import of goods from Bosnia and partly compensating for the slowdown in goods Herzegovina and Serbia (see Box 6.1). As trade exports. Recently, all Western Balkan countries wars and regional trade disputes persist, growth have seen service inflows rise, especially in in goods exports is expected to slow. These tourism. The increasing service exports are a developments may also affect economic growth welcomed development; they help to diversify throughout the Western Balkans and slow the exports and act as a counterweight to slowing expected recovery in global prices of base metals. goods exports. Box 6.1. The Central European Free Trade Agreement (CEFTA) CEFTA is a trade agreement between countries not yet members of the European Union (EU) that was founded in 1992 by Hungary, Poland, and the Czech and Slovak republics, all of which have since left to become EU members. Other former parties are Bulgaria, Croatia, Romania, and Slovenia. The current CEFTA members are Albania, Bosnia and Herzegovina, Moldova, Montenegro, North Macedonia, Serbia, and the United Nations Interim Administration Mission in Kosovo on behalf of Kosovo. All CEFTA members except Moldova have also signed the EU Stabilization and Association Agreement. CEFTA thus functions as preparation for full EU membership. As of 2006, the CEFTA agreement covers 16 policy areas, some of which go beyond tariff reforms. It is thus deeper than most other trade agreements between CEFTA countries, which cover on average 10 areas (see note to box). However, except for tariffs on agricultural and manufacturing goods, all CEFTA policy areas require consensus in settling disputes, which makes it hard to enforce CEFTA requirements. In 2018, CEFTA was deepened by an additional protocol on trade facilitation. A protocol on services liberalization is planned for 2019 and a protocol on dispute settlement should be ready for adoption by 2020. The agreement has been very effective in eliminating tariffs for all industrial goods within a short phase-out period, and in substantially reducing tariffs for a large number of agricultural goods. Despite that the estimated increases in trade for CEFTA member countries are relatively modest: they vary between 0.02 and 7.4 percent, the positive welfare impact is between 0 and 3.7 percent. In 2018, CEFTA came under stress when as a consequence of recent tensions Kosovo imposed a 100 percent tariff on Serbia and Bosnia and Herzegovina. This has deeply affected their exports to Kosovo, especially food products. The planned strengthening of CEFTA seems unlikely as long as the conflict endures. Despite recent tensions, a further deepening of CEFTA could have a substantial beneficial impact on trade. Estimates indicate that improvements in terms of dispute settlement mechanisms could increase CEFTA members’ trade and real GDP by around 2 percent in the long-term. If CEFTA were to be further expanded with provisions on movement of capital, consumer protection, labor market regulation, and environmental laws, growth in trade and real GDP would rise by an estimated 2.5 percent. A 6.7 percent gain could be achieved if the countries deepened their commitment to the level of those between EU members. Source: Alen Mulabdic and Michele Ruta, May 2018, Effects of a Deeper CEFTA, World Bank, Washington, DC. Note: Calculated using the World Bank Content of Deep Agreements Database. It is important to remember, though that the information on the content of CEFTA in the database is based on the text of the 2006 agreement as submitted to the World Trade Organization. It is likely that currently CEFTA covers more areas due to additional protocols negotiated since. 6. Exports slow amid rising international trade tensions  |  27 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Stable FDI and remittances have helped levels are too low to sustain growth over the long finance external imbalances in 2019. At an term. Moreover, while greenfield investment average of 6 percent of GDP, the contribution of peaked in 2018, a substantial share of FDI remittances to financing trade deficits remains has gone into non-tradable sectors such as real robust in the Western Balkans, especially in estate and retailing, which do not contribute Albania, Bosnia and Herzegovina, Serbia, and directly to exports. Kosovo, where they are expected to remain an essential source of trade deficit financing. The The rise in external debt in 2019 suggests that primary sources of remittances are Austria, some countries in the Western Balkans still Germany, Greece, Italy, and Switzerland. depend on external financing. The external Total FDI for the region is expected to reach debt-to-GDP ratio for the region is projected 5.2 percent of GDP, slightly less than in 2018 to remain high at 79.5 percent of GDP. While because Albania, North Macedonia, and Serbia FDI currently finances a considerable part of had smaller inflows as a percent of GDP than a the region’s CADs, there are risks associated year ago (Figure 6.3). FDI in North Macedonia with continuing high CADs, especially when and Serbia has fallen following unusually high external debt-to-GDP ratios are not only levels in 2018 (the highest since 2009 in North high but worsening. A sudden stop in foreign Macedonia and since 2011 in Serbia). The investments, continued decline in exports expected inflows for 2019 remain above the because of global trade wars and regional averages for the past five years. In Kosovo, net disputes, or an increasing reliance on imports, FDI improved to 4.1 percent of GDP, covering especially for consumption goods, would about 45 percent of the CAD financing. In amplify dependence on external financing and Bosnia and Herzegovina and Montenegro, FDI could jeopardize foreign currency reserves. In is enough to finance about 50 percent of the 2019, however, all Western Balkan countries CAD, and in Albania, North Macedonia, and are projected to keep reserves at above 4 months Serbia it can cover the entire CAD (Figure 6.4). of imports. Although FDI has supported growth in the Western Balkan countries, current investment Figure 6.3. Total FDI inflows to the region Figure 6.4. …but net FDI inflows fell in North were generally steady in 2019… Macedonia and Serbia. Four-quarter rolling sum, Euro millions, 2013–March/June 19 Net FDI-to-GDP ratio. percent of GDP 6,000 13 4 5,000 11 3 9 4,000 7 2 3,000 5 1 2,000 3 1 0 1,000 -1 -1 0 -3 -1,000 -2 -5 -2,000 -7 -3 r-13 -13 r-14 -14 r-15 -15 r-16 -16 r-17 -17 r-18 Ma Sep Ma Sep Ma Sep Ma Sep Ma Sep Ma MNE ALB SRB KOS MKD BIH WB6 ▬▬FDI inflows ▬▬Portfolio investment inflows ▬▬Other investment inflows JJNet FDI to GDP 2019e, percent QQ2018–19e change in net FDI to GDP (pp) Source: National authorities and World Bank staff calculations. 28  |  6. Exports slow amid rising international trade tensions RISING UNCERTAINTIES The outlook is positive but vulnerable to rising external 7.  risks After slowing in 2019, medium-term The positive outlook is driven by growth prospects for the Western Balkans consumption while the contribution of are rather positive, with annual growth investment to GDP growth is expected projected to increase to 3.6 percent in 2020 to slow. The contribution of investment to and 3.8 percent in 2021  (Table 7.1). The regional growth is expected to slip slightly, from benign outlook applies to all countries except 1.3 pp in 2019 to 1.1 pp in 2020 and 1 pp in Montenegro where the phasing-out of an 2021; but that is still slightly above the 2012– investment cycle is expected to dampen activity, 18 average of 0.7 percent. In North Macedonia, with growth falling to 2.8 percent in 2020 and growth will be supported by contributions 2.7 percent in 2021. But in several countries from investment and household consumption, the positive growth outlook is supported boosted by more people being in work and by one-time factors and masks the region’s higher wages. Labor income gains will also fuel exposures to downside risks. In Albania, energy growth in Albania, mainly based on private production is expected to rebound as rainfall consumption. Private consumption will also is assumed to return to historical averages. push up growth in Bosnia and Herzegovina In Kosovo, several large public investment and in Serbia. In Serbia, a drop in the negative projects in transport are expected to advance. contribution from net exports is also expected. And in Serbia, consumption is expected to At the same time, foreign investment in the remain robust in 2020 as increases in public Western Balkans is increasing. In 2018, the sector wages and pensions materialize. Overall, region recorded its highest greenfield FDI economic growth in the region is projected to inflows in a decade, and FDI net inflows are be stronger than in the EU and the Central and expected to hold steady at about 5.2 percent of Eastern Europe region through 2021. GDP through 2021. Table 7.1. Growth Rates in the Western The positive outlook is, however, vulnerable Balkans, 2017–21f to external and domestic risks that could 2017 2018e 2019f 2020f 2021f affect growth, job creation, and poverty Albania 3.8 4.1 2.9 3.4 3.6 reduction. High fiscal and current account Bosnia and 3.2 3.6 3.1 3.4 3.9 deficits in several countries, as well as Herzegovina dependence on external financing and Kosovo 4.2 3.8 4.0 4.2 4.1 remittances, expose countries in the region to North Macedonia 0.2 2.7 3.1 3.2 3.3 external economic shocks. The major external Montenegro 4.7 4.9 3.0 2.8 2.7 risks are economic slowdowns in international Serbia 2.0 4.2 3.3 3.9 4.0 trade partners, in particular the European Western Balkans 2.6 3.9 3.2 3.6 3.8 Union (EU), which is by far the region’s largest EU28 2.5 2.0 1.4 1.3 1.4 trading partner. The high degree of openness Source: World Bank (Global Economic Prospects) working assumptions, national statistical offices, World Bank estimates. to trade and capital flows and the presence of major commodity exporters thus expose the 7. The outlook is positive but vulnerable to rising external risks  |  29 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 region to global shocks, deceleration in the Medium- and long-term patterns of economic economies of trading partners, and an escalation development in the region depend heavily on of trade tensions, especially for specific sectors the pace of structural reforms. The Western like automobiles (see Box 7.1 on external risks). Balkans continue to suffer from numerous The recent slowdown of the German industry, structural deficiencies, among them skills especially of car production which reached mismatches, low youth employment rates, high 2009 levels (mostly driven by a fall in demand informality, low productivity and innovation, for diesel cars), translates into a downside risk limited access to financing, and weak business for the economies with strong automotive and environments. The severe inefficiency and automotive parts industries, such as Bosnia and low productivity that characterize the region’s Herzegovina, North Macedonia, and Serbia. economies translate into a sizable gap in each Domestically, positive growth outlooks in some country between actual and potential output— Western Balkan countries are particularly fragile what could be achieved given the available input given their underpinning on one-time factors, and technology. Boosting productivity growth mainly the execution of large capital projects, requires reinforcing the state institutions that which could greatly undermine growth if protect the rule of law and safeguarding private they don’t materialize or if delays continue to sector competition. Both will strengthen anti- plague execution. Political uncertainty, credit corruption mechanisms and level the playing conditions, and macroeconomic stability are field between firms. Higher productivity other key domestic risk concerns, as well as also requires improving public services to weather shocks, which affect both agriculture boost human capital while preserving macro- and energy production, both of which are vital fiscal and financial stability. Together, these to the economies of the region. structural reforms would help unlock stronger, Box 7.1. Emerging Global Risks The global economy continues to show signs of marked deceleration. The pace of industrial production growth has nearly halved since the start of 2019 and business confidence continues to fall. Tracking a decline in consumer confidence, the services sector has also begun to slow. Since June the realization of certain downside risks—including re-escalation of trade and geopolitical tensions—has darkened the global growth outlook and generated substantial commodities market volatility. Market expectations of GDP growth have deteriorated in response, with average forecasts for growth edging down globally by 0.1 pp and for Emerging Market and Developing Economies (EMDE) growth by 0.2 pp (Figure B.7.1). Given current working assumptions, worldwide more than half of the economies are expected to slow in 2019, with global growth anticipated to drop to 2.5 percent in both 2019 and 2020. Cyclical headwinds and persistent policy uncertainty continue to dampen growth in global trade. Trade tensions have been rising throughout 2019, most notably between the United States and China. Growth in the volume of global goods traded has plunged, and the sustained contraction in new export orders suggests that the slide will continue (Figure B.7.2). The working assumption for global trade growth in 2019 has been slashed since the start of the year, to 1.9 percent, the worst pace since the global financial crisis. By yearend, tariffs will cover nearly all U.S. imports from China and more than two-thirds of Chinese imports from the U.S. 30  |  7. The outlook is positive but vulnerable to rising external risks RISING UNCERTAINTIES Box 7.1 continued Figure B.7.1. Forecasts of Growth, 4/28– Figure B.7.2. Growth in the Volume of 8/19 Global Goods Trade and New Export Orders, 1/16–7/18 Percent Percent Percent, 3m-on-3m saar Index, 50+ = expansion 3.2 5.2 15 56 10 54 2.8 4.8 5 52 2.4 4.4 0 50 2.0 4.0 -5 48 1.6 3.6 -10 46 -18 un-18 ug-18 ct-18 ec-18 eb-19 pr-19 un-19 ug-19 -16 16 -17 Jul- 17 -18 18 -19 19 Apr J A O D F A J A Jan Jul- Jan Jan Jul- Jan Jul- ▬▬World ▬▬Advanced economies ▬▬EMDEs, rhs JJGoods trade ▬▬New export orders, rhs Emerging data in major economies point to a somewhat abrupt slowdown in activity as the global trade slowdown takes its toll. In the Euro Area, political uncertainty, stemming from concerns about a perhaps disorderly Brexit and debt sustainability in Italy, is also denting confidence: preliminary estimates suggest that in 2020 growth in the Euro Area will decelerate to 1.1 percent rather than firming up to 1.4 percent as was expected. Growth in China has continued to ebb amid heightened trade tensions with the United States, with policy support only partially offsetting the negative impact of higher tariffs. Risks to global growth are definitely to the downside. Among downside risks are an intensification of trade tensions or other policy uncertainties, which could weigh on investment and worsen financial and commodity market volatility; sudden slowdowns in major economies that could generate substantial spillover effects for EMDEs; and new EMDE financial stress episodes, amplified by rising debt, corporate sector vulnerabilities, and heightened refinancing pressures. The probability of growth in 2020 being at least 1 pp below current projections is estimated at close to [20] percent— comparable to the 2001 global downturn. A further escalation of trade tensions between the U.S. and China could mean significant economic losses for exporters of products targeted, with trade costs cascading into other sectors. Similarly, a deterioration in U.S.–Europe trade relations, particularly with respect to auto tariffs, could bring major disruptions in tightly integrated value chains. A disorderly Brexit from the EU would cause uncertainty to spike and further block trade flows, causing dislocating shifts in financial markets. A sharper-than-expected deceleration in major economies—such as the Euro Area, the U.S., or China—would seriously jeopardize global and EMDE growth. A worsening slowdown in the Euro Area could generate adverse spillovers to Europe’s EMDEs. The Europe and Central Asia (ECA) region is generally open to trade and capital flows given its increasing integration with the EU and the presence of several large commodity-exporting economies, which leaves the region vulnerable to growth shocks originating from outside ECA. Global spillovers to ECA are estimated to be larger than spillovers from Russia or Turkey, the region’s two largest economies. Over two years a 1 pp decline in growth in the rest of the world subtracts 1.7 pp from growth in ECA economies (World Bank 2016). A substantial deceleration in China would push down commodity prices worldwide, with a disproportionately large impact on ECA commodity exporters (World Bank 2019). 7. The outlook is positive but vulnerable to rising external risks  |  31 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Box 7.1 continued The Euro Area is a vital trading partner and source of financial flows to ECA—a worse than expected slowdown could have spillovers to ECA through trade, remittances, and banking system channels  (Figure B.7.3). The Western Balkans is no exception—the EU is its single largest trading partner and an important export destination, as well as a substantial source of the region’s FDI and remittances (Figure B.7.4). Weaker economies in key trading partners could dampen external demand for exports from the Western Balkans. Among major export destinations for the Western Balkans, for instance, are Italy and Germany, where fragile growth outlooks could depress export growth in the region. Furthermore, an escalation of trade tensions between the United States and Europe that affects automobiles could disrupt tightly integrated value chains in the Western Balkans, especially in North Macedonia and Serbia (World Bank 2019). Figure B.7.3. Goods Exports by Destination, Figure B.7.4. Remittances from the EU, 2017 Percent 100 60 90 80 50 70 40 60 50 30 40 30 20 20 10 10 0 0 Europe and Central Asia Western Balkans Europe and Central Asia Western Balkans JJWithin region JJEuro Area JJRest of Europe JJRest of World Source: Bloomberg, Consensus Economics, CPB Bureau for Economic Policy Analysis, Haver Analytics, International Monetary Fund, World Bank. more equitable, and more sustainable growth, a risk for regional integration and economic ensuring faster convergence with EU income development. levels. Aspirations to EU candidacy and accession, Political tensions continue to be an obstacle however, are an important incentive to to internal stability and regional integration. overcome internal dissension and push for They also make it difficult for each country to reforms. For Bosnia and Herzegovina, the pursue much-needed structural reforms–and aspiration to become an EU candidate may the tensions may build as general elections help overcome internal differences and be a approach: Elections are planned for 2020 in force for reform. All countries in the region North Macedonia, Montenegro, and Serbia; should focus their efforts on the critical areas and 2021 in Albania and municipal elections in of the rule of law and fundamental rights to Bosnia and Herzegovina. A government is yet advance accession within the 2018 Western to be formed in Bosnia and Herzegovina, where Balkans Strategy (EU Commission 2019). the last general election was held in October Achieving more trade integration, both 2018. Besides domestic political disputes, regionally and internationally, will help firms in poor regional cooperation, expressed in trade Western Balkan countries reach larger markets barriers imposed against each other, constitutes and benefit from economies of scale and thus productivity growth. 32  |  7. The outlook is positive but vulnerable to rising external risks Country Notes WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Albania • With lower rainfall slashing energy production. growth is projected to slow to 2.9 percent in 2019. • The labor market continued to improve, and unemployment reached a new low of 11.5 percent in June 2019. • Contained spending and clearance of arrears helped bring down public debt, but off-balance risks, e.g., from public-private partnerships, are mounting. • In the medium term, growth is expected to rise to about 3.5 percent backed by domestic demand. • Fiscal consolidation, more efficient public spending efficiency, and structural reforms are critical for sustainable and equitable growth. Recent Economic Developments of the second quarter, labor force participation rose by 1.24 pp year-on-year (y-o-y), but the gap After expanding by 4.1 percent in 2018, between male and female participation remains annual growth for 2019 is projected to slow large. In Q2 unemployment reached a record to 2.9 percent. A drastic decline in rainfall in low of 11.5 percent. Real wages increased on the first half of the year (H1) cut hydroelectric average by 3.4 percent, mostly in services (trade power production in half and lowered GDP and transport, and tourism). growth by more than half percentage point (pp). Services and construction led growth. Inflation has declined since 2018, reversing Despite growing political tensions, domestic the recent trend. Average inflation through demand heightened. Net exports reduced July fell from 2.1 percent in 2018 to growth by –0.4 pp as stagnant growth in 1.5 percent, where it is forecast to end the year. trade partners limited exports of traditional Low imported inflation from trade partners goods, and energy exports declined. Improving and appreciation of the lek were the main employment, higher wages, and growth in factors. Domestic inflation pressures were also consumer credit drove private consumption, weak because of continued underutilization of which contributed 2.1 pp to GDP growth. production capacities; the estimated output Meanwhile, better credit conditions and gap is –0.9 percent. The drop in inflation government infrastructure spending pushed tracked the one in food inflation, mirroring up investment, contributing 0.5 pp. In H2, as what was happening in Albania’s main trading the energy shock abates, Albania’s economic partners. Consistent with its price-stability growth is expected to improve. objective, and to lessen the impact of the lek appreciation on domestic prices, the Bank Despite lower growth job creation of Albania (BoA) has held its policy rate at a strengthened and unemployment declined. record low of 1 percent since June 2018. The Growth in jobs increased to 3.4 percent in the change has been transmitted to short-term second quarter of 2019 after a slight deceleration government securities and deposit and lending in the first quarter. New jobs were created in rates. During H1, the real effective exchange services industry and agriculture. At the end rate appreciated by 4.5 percent as the nominal 34  | Albania RISING UNCERTAINTIES appreciation effect dominated the negative capital, private equity, insurance, mutual funds, inflation differential with trading partners. and microfinance, especially with support from better supervision of the financial sector The banking sector is well-capitalized and and smooth operation of government bond profitable. All banks exceeded the Basel III markets. required minimum capital-adequacy ratio of 12 percent, with the sector averaging While Albania’s debt-to-GDP declined in 18.5 percent in June; the liquidity ratio was 2019, risks generated by contingent liabilities adequate at 21 percent. Loan portfolios and SOEs remain high. The revenues-to-GDP improved as the BoA continued to restructure ratio has dropped from 27.6 percent of GDP the nonperforming loans (NPLs) of large in 2018 to an estimated 27.3 percent. Revenue borrowers, which with mandatory write-offs, growth in 2019 was limited by lower GDP helped reduce NPLs to 11.2 percent of total growth and by accelerated repayment of VAT- loans by June, down from 25.0 percent y-o-y refund arrears. Personal income tax revenue in 2008.1 Reducing the NPL ratio is a BoA and social security contributions rose slightly, priority. A new insolvency law was adopted in supported by higher wages and efforts to reduce 2016, and the BoA is preparing a framework informality. Meanwhile, tighter controls on for banks to use in voluntary, out-of-court social transfers and subsidies curbed current settlements to resolve large NPLs. spending. Due to lower than projected revenues, capital spending relative to GDP Monetary easing and improvements in the fell by 0.1 pp. The government has recently loan portfolio are beginning to affect growth increased the use of public-private partnerships in credit to the private sector. In H1 loans (PPPs) to finance infrastructure, health care, to the private sector grew by 6.8, pushing the and education projects. Budgetary arrears credit-to-GDP ratio to 35.9 percent from 35.3 (e.g., VAT refunds and local-government at the end of 2018. In particular, lower interest transfers) amounted to about 1.5 percent of rates on loans in leks have stimulated demand GDP in 2018. The budget deficit is expected for domestic currency loans, which grew by to widen in 2019 to 2.2 percent of GDP as the 7.9 percent in H1. Credit to businesses for government reduces VAT arrears to the private investment has also improved, unlike previous sector; and public debt, including guarantees trends.2 However, corporate lending is still and arrears, is expected to fall to 68.4 percent of limited and would be encouraged by a wider GDP. In August, Moody’s confirmed its long- range of financing instruments. Since bank term sovereign credit ratings for Albania at B+. assets account for over 90 percent of total financial sector assets, sector diversification The energy shock and lower foreign demand and enhanced business access to finance have exposed external vulnerabilities for would benefit from policies to create new Albania. The current account deficit (CAD) mechanisms for leasing, factoring, venture is highly sensitive to commodity prices and rainfall, which largely determines energy 1 Source: BoA Monetary Policy Report August 2019. The figures production. Thus, the CAD is expected to refer to the change in credit outstanding after NPL write-off widen from 6.7 percent of GDP in 2018 to effects. 2 In June 2019, credit to businesses grew by an annualized 7 percent. 7 percent. Foreign direct investment (FDI) Albania  |  35 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 is expected to remain unchanged as the By 2021 the fiscal deficit is expected to fall to investment phase for large projects in energy 1.7 percent of GDP. The medium-term fiscal and gas transmission ends. Since 2016 foreign plan calls for fiscal consolidation to continue exchange reserves have held steady at over six until 2022, which should generate savings months of goods and services import coverage. on the wage bill, goods, and services and on Large reserves help mitigate the risks posed by transfers to social insurance beneficiaries and high external debt, which is projected to reach local governments. Sustained capital spending 65.7 percent of GDP in 2019. on infrastructure is planned at 4.8 percent of GDP. And gradual fiscal consolidation combined with continued economic growth Outlook and Risks is forecast to lower the debt-to-GDP ratio to 60 percent. Growth is projected to accelerate to about 3.5 percent in 2020–21 as increased The country’s economic prospects are economic dynamism gradually closes vulnerable to significant downside risks. the output gap. Growth will increasingly Lower demand from foreign trade partners depend on labor income gains fueling private could constrain growth in the short to medium consumption. In the short term, a return of term, worsen labor market conditions, the energy balance to a more normal level will and expose the country to further external alleviate the trade balance and net exports. vulnerability. Preserving macro-fiscal stability Beyond the short term, recent positive trends is crucial to support sustainable growth; that in Albanian exports stemming from expanding calls for further streamlining of spending, markets, will moderate, in reflection of stagnant maximizing tax revenues by expanding the tax growth in the global economy. Investment will base, and improving revenue administration, also contribute to growth, fueled by public and for managing fiscal risks from PPPs projects and private investment, assuming and SOEs. Fostering inclusive growth also continued progress on structural reforms in, requires better conditions for private sector e.g., the justice system and the financial sector. development, such as improving the business As the economy grows and capacity utilization environment, and enhancing financial access, recovers, long-term trends are expected to push energy security, and human capital. inflation close to its historical averages in the second half of 2021. 36  | Albania RISING UNCERTAINTIES Investment and recovery in consumption are Public debt is declining but fiscal consolidation expected to drive growth in 2019. was lower than in the past. Growth contributions, percent Percent of GDP 6 80 0 70 -1 4 60 -2 2 50 -3 0 40 -4 30 -2 -5 20 -4 -6 10 -6 0 -7 4 5 6 7 8 9 0 1 0 1 2 3 4 5 6 7 8 9 0 1 201 201 201 201 201 201 202 202 201 201 201 201 201 201 201 201 201 201 202 202 JJInvestment JJNet exports JJConsumption ▬▬Real GDP growth, % JJPublic debt ▬▬Fiscal balance, rhs Source: Instat and World Bank. Source: Ministry of Finance and World Bank. Labor markets improved, though at a slower Imported goods inflation and exchange rate pace. appreciation kept inflation outside the 3 ±1 percent target band, and monetary policy was again accommodative. Percentage Percentage 60 5 50 4 40 3 30 2 20 1 10 0 0 12 13 14 15 16 17 18 -10 ug-11 ug-12 ug-13 ug-14 ug-15 ug-16 ug-17 ug-18 ug-19 Q4- Q4- Q4- Q4- Q4- Q4- Q4- Aug A A A A A A A A A ▬▬Employment ▬▬Unemployment Source: Instat. Source: Instat. The energy shock and a drop in foreign As asset quality improved, monetary stimulus demand have exposed the country’s external was transmitted into private sector credit vulnerabilities. growth. Current account balance, percent of GDP Credit to the private sector, growth rate in percent 2009 2017 2018 2019e 5 0 4 -2 3 -4 2 -6 -8 1 -10 0 -12 -1 -14 -2 -16 -3 -13 -14 -14 -15 -15 -16 -16 -17 c-17 -18 -18 -19 -18 Dec Jun Dec Jun Dec Jun Dec Jun De Jun Dec Jun Source: Central Bank and World Bank. Source: Central Bank and World Bank. Albania  |  37 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 ALBANIA 2014 2015 2016 2017 2018 2019e 2020f 2021f Real GDP growth (percent) 1.8 2.2 3.3 3.8 4.1 2.9 3.4 3.6 Composition (percentage points): Consumption 5.9 0.0 4.8 3.7 3.9 2.8 2.5 2.8 Investment -2.6 0.6 -1.7 -0.2 1.0 0.5 1.1 1.0 Net exports -1.6 1.6 0.2 0.3 -0.8 -0.4 -0.2 -0.2 Exports 0.3 0.3 3.3 4.0 1.0 0.6 1.4 1.4 Imports (-) 1.9 -1.3 3.1 3.7 1.8 1.0 1.6 1.6 Consumer price inflation 1.6 1.9 1.3 2.0 2.1 1.5 2.7 2.9 (percent, period average) Public revenues (percent of GDP) 26.3 26.4 27.4 27.7 27.6 27.3 27.4 27.5 Public expenditures (percent of GDP) 32.3 30.9 29.6 29.8 29.3 29.6 29.4 29.2 Of which: Wage bill (percent of GDP) 5.1 5.1 4.6 4.7 4.5 4.5 4.5 4.5 Social benefits (percent of GDP) 9.9 9.9 10.3 10.4 10.2 10.4 10.3 10.2 Capital expenditures (percent of GDP) 4.3 4.4 4.0 4.4 4.8 4.7 4.8 4.8 Fiscal balance (percent of GDP) -6.0 -4.9 -1.8 -2.0 -1.8 -2.2 -2.0 -1.7 Primary fiscal balance (percent of GDP) -3.1 -2.2 0.5 0.0 0.4 0.0 0.2 0.4 Public debt (percent of GDP) 66.1 69.1 68.7 67.8 64.6 63.0 62.1 59.6 Public and publicly guaranteed debt 72.0 72.7 72.3 71.9 69.7 68.4 66.6 64.3 (percent of GDP) Of which: External (percent of GDP) 29.6 34.2 32.6 32.6 32.9 32.4 32.6 30.7 Goods exports (percent of GDP) 9.3 7.5 6.7 6.9 7.7 5.5 5.7 5.9 Goods imports (percent of GDP) 31.6 29.9 30.9 31.3 30.2 32.9 33.5 34.0 Net services exports (percent of GDP) 3.2 5.1 7.4 9.4 8.6 12.9 13.4 14.2 Trade balance (percent of GDP) -19.0 -17.3 -16.8 -15.1 -13.8 -14.5 -14.4 -14.9 Remittance inflows (percent of GDP) 5.9 5.8 5.7 5.5 5.2 5.2 4.9 4.8 Current account balance (percent of GDP) -10.8 -8.6 -7.6 -7.5 -6.7 -7.0 -6.4 -6.1 Net foreign direct investment inflows 8.1 8.0 8.7 8.6 8.0 7.8 7.5 6.9 (percent of GDP) External debt (percent of GDP) 69.5 74.4 73.5 68.7 62.9 60.6 59.9 56.3 Real private credit growth -1.3 -1.8 -2.1 -2.3 -3.0 n.a. n.a. n.a. (percent, period average) Nonperforming loans 22.4 18.2 18.3 13.2 11.1 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 17.5 17.1 15.2 13.7 12.3 11.5 n.a. 0.0 Youth unemployment rate 32.5 33.2 28.9 25.9 23.1 n.a. n.a. n.a. (percent, period average) Labor force participation rate 53.7 55.7 57.5 58.3 59.4 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 10,645 10,926 11,276 11,693 n.a. n.a. n.a. n.a. Sources: Country authorities, World Bank estimates and projections. Note: Youth unemployment rate is for labor force aged 15–29. Statistical discrepancy contribution is divided at the ratio of 80 percent and 20 percent between Consumption and Investment respectively. Change in inventories is included in Investments. 38  | Albania RISING UNCERTAINTIES Bosnia and Herzegovina • Having exceeded expectations by reaching 3.6 percent in 2018, economic growth is expected to down-shift slightly in 2019. • In the medium term, with a fully operational government in place and the implementation of structural reforms motivated by BiH aspiration to gain EU candidate status, growth is likely to pick up again. • Because of a planned increase in public investments and a rise in transfers and wages, the fiscal stance is expected to deteriorate this year but then improve gradually as fiscal tightening resumes. • Risks to the outlook are fairly balanced: Externally, slow growth in BiH’s main trading partner, the EU, is the main downside risk. Domestically, further delays in government formation since the October 2018 general election and municipal elections in 2020 could slow both reform and growth. Recent Economic Developments Unemployment is at its lowest in over a decade. The unemployment rate declined Growth is expected to slow to 3.1 percent from 18.4 percent in 2018 to 15.7 percent in 2019, down from 3.6 percent in 2018. in 2019, driven by a slight rise in demand for Softening growth is to a large extent the result labor and a likely reduction in the working-age of a slow-down in net exports. Owing to population.3 Employment rate has risen from continuing global trade wars and regional trade 34.3 to 35.5 percent this year, with industry disputes, the trade balance figures weakened and services creating the majority of jobs. But in the first half of 2019 and are expected despite the improvements in the labor market, to worsen in the short term and offset BiH and recent stable economic growth, gains in growth momentum. In the first half of 2019, employment are modest; today by regional external demand slowed, affecting both exports standards employment in BiH is still low. (–5.7 percent year-on-year [y/y]) and imports Addressing structural rigidities will be crucial if (–3.5 percent y/y). The slowdown in external BiH is to accelerate gains in job creation. demand, is estimated to be counterbalanced by growth in consumption (2.6 percentage points Prices continue trending downward this [pp]) and investment (0.4 pp). Economic year. Higher prices of transport, tobacco, and activity is still supported by robust, though rental housing pushed up consumer prices by moderating, growth in private consumption an average of 1.4 percent in 2018. Because food owing to a steady inflow of remittances, growth and transport are the two largest components in consumer credit, and rising real wages. The of the consumer price index, the global decline drivers of production remain the same with in food and energy prices has eased inflationary services contributing 2.4 pp, industry 0.5pp, pressures. In June 2019 consumer prices rose and agriculture 0.2 pp. by 0.3 percent y/y. down from 1.5 percent y/y in January. Significantly, improvement in the 3 2019 Labor Force Survey. Bosnia and Herzegovina  |  39 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 labor market (lower unemployment and higher of BiH’s main markets for milk, slowed when wages) had no impact on inflation, which is in violation of the CEFTA agreement Kosovo largely determined by such supply-side factors imposed a 100 percent tariff on the import as less inflation in the euro area and the region of goods from BiH. Introduction of the tariff and the effect of oil and food prices on the has affected all BiH exports to Kosovo but world market. especially dietary products like milk. Other components of the CAD, such as the services In 2019, the fiscal balance is expected to turn surplus arising from construction, transport, to deficit. The latest consolidated data estimate travel, and remittances, were almost unchanged there was a 2.2 percent of GDP surplus in 2018.4 and have been sufficient to finance a significant The 2018 fiscal outcome is expected because part of the CAD, supported by FDI and other of the combined effect of stronger collection investment. It is estimated that in 2019 FDI of indirect taxes, sluggish capital spending will cover 50 percent of the CAD, with the reflecting implementation delays due to lack balance financed by new borrowing. For 2019 of government formation in the Federation of total BiH external debt-to-GDP is projected to BiH (FBiH) and state institutions, and higher stay below 66 percent. current spending on. e.g., veteran benefits in FBiH, and higher wages in Republika Srpska. The banking sector is liquid and well- In 2019, the surplus position is expected to be capitalized. System-wide, the nonperforming reversed as current spending continues to rise loan (NPL) ratio is heading down. At the and public investment picks up. Total public end of the first quarter, the share of NPLs in debt, which is still moderate, is projected to commercial bank portfolios had gone down decline to 34.6 percent of GDP after 2019. In from 8.8 percent of total loans at the end of 2018 March, Standard & Poor’s confirmed its long- to 8.5 percent. Profitability is also on the rise— term B sovereign credit rating for BiH and in the first quarter return on average equity was raised its outlook from stable to positive—the 12 percent, up from 9.6 percent at the end of first improvement in the country’s outlook 2018. The capital-to-assets ratio has risen from since 2012. 13.2 percent in 2018 to 13.5 percent. Capital buffers are within regulatory requirements. Having narrowed slightly in 2018, the current account deficit (CAD) is expected to widen to 4.3 percent in 2019 as exports Outlook and Risks decline by 0.9 percent and imports rise slowly by 2.2 percent. Exports have been By 2021, supported primarily by weighed down by the slowdown in economic consumption and to some extent by public growth in the EU, a significant trading partner investment, economic growth is projected to for BiH; lower global prices for aluminum, a strengthen to 3.9 percent. BiH’s commitment major BiH export; and loss of markets for some to gaining EU candidate status is seen as a commodities due to regional trade disputes. key reason to advance the country’s structural For instance, export of milk to Kosovo, one reform agenda. As and when a new government is formed and structural reforms are launched, a 4 See Consolidated CBBiH data, available at the CBBiH Panorama web portal. moderate rise in growth is expected, with higher 40  |  Bosnia and Herzegovina RISING UNCERTAINTIES investment in infrastructure. In the medium term, external deficits are expected to persist, mostly owing to the trade balance, which will move in line with global oil and aluminum prices. Remittances are likely to hold steady and will continue to support consumption, which will remain a major driver of growth in the medium term. In the medium term, too, labor market improvements should strengthen as investments in energy, construction, and tourism support job creation. Real GDP growth is therefore projected to build gradually to 3.9 percent by 2021. Unleashing the potential of the private sector is still a major challenge for BiH and will continue to preclude heightened growth over the medium term. Private sector growth is lackluster and insufficient to improve labor market outcomes. It continues to be restricted by a high tax burden on labor, a poor business environment, skills gaps, and a large public sector. Moreover, despite good fiscal outcomes in earlier years, public finances today are still characterized by arrears accumulation, structural rigidities on the spending side manifested in high current spending, and poor targeting of social assistance benefits. Notable risks, both domestic and external, persist. The main domestic risk is the challenging political environment, which makes advancement of structural reform difficult and will continue to delay EU integration. Externally, slow growth in the EU and rising regional and global trade tensions are the main downside risks. Bosnia and Herzegovina  |  41 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 GDP growth strengthened in 2018, but Inflation remains low and price pressures momentum has since softened. eased in the first half of 2019. Contributions to growth, percentage points of GDP Percent y-o-y 4 2.5 3 2.0 2 1.5 1 1.0 0 0.5 -1 -2 0 201 2 201 3 201 4 201 5 201 6 201 7 8e -17 y-17 -17 -18 y-18 -18 -19 y-19 201 Jan Ma Sep Jan Ma Sep Jan Ma JJAgriculture JJIndustry JJServices QQOverall GDP growth JJOverall CPI inflation Source: BiH Agency for Statistics, World Bank. Source: BiH Agency for Statistics, World Bank. Indirect tax revenues continue to rise... …but higher public spending is expected to put the fiscal balance in a deficit position. Real 3 months moving average (3mma), percent y-o-y Percent of GDP 14 3 12 10 2 8 6 1 4 2 0 0 -2 -4 -1 -17 y-17 -17 -18 y-18 -18 -19 y-19 201 5 201 6 201 7 8e 9f 0f 202 1f Jan Ma Sep Jan Ma Sep Jan Ma 201 201 202 ▬▬Growth in total indirect revenues (in 2015 prices, 3mma yoy) JJGeneral government fiscal balance ▬▬Growth in net indirect revenues (in 2015 prices, 3mma yoy) Source: BiH Indirect Tax Office, World Bank. Source: Fiscal authorities, World Bank estimates. The deficit in the goods trade continues to Nonperforming loans in commercial bank widen. portfolios are declining but still high. 3 mma, percent y-o-y, and the goods trade balance in KM Percent billions 30 8 18 6 16 20 14 4 12 10 2 10 0 0 8 -2 6 -10 4 -4 2 -20 -6 0 -30 -8 -2 -15 -15 -15 -16 -16 -16 -17 -17 -17 -18 -18 -18 -19 -19 13 14 15 16 17 18 19 Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Q1- Q1- Q1- Q1- Q1- Q1- Q1- JJTrade balance (12m sum, rhs) ▬▬Exports (3mma y/y, lhs) JJCapital adequacy (tier 1 capital to risk weighted assets) ▬▬Imports (3mma y/y, lhs) ▬▬Asset quality (NPLs to total loans) ▬▬Profitability (return on equity) Source: BiH Agency for Statistics, World Bank. Source: Central Bank of BiH, World Bank calculations. 42  |  Bosnia and Herzegovina RISING UNCERTAINTIES BOSNIA AND HERZEGOVINA 2014 2015 2016 2017f 2018 2019e 2020f 2021f Real GDP growth (percent) 1.1 3.1 3.1 3.2 3.6 3.1 3.4 3.9 Composition (percentage points): Consumption n.a. n.a n.a n.a n.a 2.6 3.1 2.9 Investment n.a. n.a n.a n.a n.a 0.4 0.4 0.9 Net exports n.a. n.a n.a n.a n.a 0.0 -0.1 0.1 Exports n.a n.a n.a n.a n.a 0.4 0.6 1.1 Imports (-) n.a n.a n.a n.a n.a 0.4 0.6 1.1 Consumer price inflation (percent, period average) -0.9 0.0 -1.6 0.8 1.4 0.8 0.8 0.6 Public revenues (percent of GDP) 43.7 43.1 42.7 43.0 42.8 41.8 42.0 41.7 Public expenditures (percent of GDP) 45.8 42.5 41.5 40.4 40.6 42.4 41.4 40.3 Of which: Wage bill (percent of GDP) 11.9 11.5 11.0 10.6 10.3 10.2 10.0 9.6 Social benefits (percent of GDP) 17.0 16.5 15.9 15.2 15.3 17.0 16.8 16.6 Capital expenditures (percent of GDP) 4.3 2.0 2.4 2.4 2.8 2.5 2.3 2.1 Fiscal balance (percent of GDP) -2.0 0.7 1.2 2.6 2.2 -0.6 0.6 1.4 Primary fiscal balance (percent of GDP) -1.2 1.6 2.9 2.9 2.9 0.2 1.4 2.2 Public debt (percent of GDP) 41.6 41.9 42.3 36.1 34.1 33.2 32.3 31.4 Public and publicly guaranteed debt 43.4 43.6 42.1 37.7 35.6 34.6 33.7 32.7 (percent of GDP) Of which: External (percent of GDP) 34.3 35.0 34.3 30.6 29.8 28.9 28.3 27.6 Goods exports (percent of GDP) 25.0 25.2 25.7 29.8 30.2 28.7 28.7 28.5 Goods imports (percent of GDP) 53.8 50.3 49.4 53.3 52.7 51.6 52.3 53.1 Net services exports (percent of GDP) 6.1 6.7 7.0 7.2 7.4 7.5 7.4 7.5 Trade balance (percent of GDP) -28.8 -25.2 -23.6 -23.5 -22.5 -23.0 -23.7 -24.6 Remittance inflows (percent of GDP) 8.4 8.3 8.2 8.4 8.1 8.0 7.7 8.0 Current account balance (percent of GDP) -7.5 -5.3 -4.7 -4.7 -4.3 -4.5 -5.3 -6.0 Foreign direct investment inflows 2.9 1.8 1.7 2.1 2.2 2.3 2.3 2.4 (percent of GDP) External debt (percent of GDP) 76.3 72.2 72.2 68.5 66.1 65.8 65.8 65.5 Real private credit growth (percent, period average) 3.1 1.1 3.1 6.2 6.8 5.8 n.a n.a Nonperforming loans 14.2 13.7 11.8 10.0 8.8 8.5 n.a n.a (percent of gross loans, end of period) Unemployment rate (percent, period average) 27.5 27.7 25.4 20.5 18.4 15.7 n.a n.a Youth unemployment rate (percent, period average) 62.9 62.3 54.3 45.8 38.8 33.8 n.a n.a Labor force participation rate 43.7 44.1 43.1 42.7 42.1 42.1 n.a n.a (percent, period average) GDP per capita, PPP (current international $) 11,164 11,526 12,173 12,875 13,200 13,775 14,258 14,550 Sources: Country authorities, World Bank estimates and projections. Note: Nonperforming loans show year-to-date actuals. Bosnia and Herzegovina  |  43 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Kosovo5 • For 2019 growth is projected to reach 4 percent, up from 3.8 percent, driven by consumption, service exports, and investment. • The overall budget deficit is expected to stay just below 3 percent of GDP, and within the 2 percent fiscal rule limit which excludes capital spending financed by privatization proceeds and international financial institutions. slight underperformance in revenue, compared to the plan, will be overcompensated with a significant under execution of capital projects. • Poorly targeted social protection spending remains high and continues to limit fiscal space. • The outlook is positive, with growth averaging 4.2 percent for 2020–21, but there are downside risks related to domestic and regional politics dynamics, possible delays in investment plans due to upcoming elections, higher than projected cost of the new law on public salaries, and the stability of international metals prices. Recent Economic Developments unemployment eased to 49.1 percent, down by 5.9 pp y-o-y. However, the share of NEET Growth is expected to edge up to 4 percent youth (the percentage of young people that are in 2019, from 3.8 percent in 2018. For the not in training, education, or employment) are year, private consumption is expected to add high at 31.7 percent. 2.9 pp to growth, thanks to higher consumer lending, remittances, and public wages; and The 2019 overall fiscal deficit is expected public consumption is expected to add another to be 2.9 percent, d  riven by higher capital 1.6 pp. The contribution of investment to investment—financed in part by privatization growth is projected to be only 1.1 pp because proceeds—and higher untargeted social late approval of the budget law led to delays protection spending. Total spending is in the execution of public investment plans. projected to grow by 10 percent, based on a Elections in 2019 may further delay execution 12 percent growth in current spending and of the capital budget. Despite strong growth 4 percent higher capital spending. Social in services exports, net exports are expected to protection spending will exceed the budgeted subtract 1.4 pp from growth. amount; as payments for war veterans are likely to be higher than planned because amendments Labor force participation continues to be low, to the law to contain the costs were not despite the chronically high unemployment. implemented. Total revenues are expected In 2019 Q2 unemployment went down, by to rise by 10.9 percent y-o-y, supported by 4.1 pp, from the same period last year, due to higher economic growth and better collection higher employment but also lower labor force of tax debt. VAT collection should grow by participation. Employment rate increased 11 percent; CIT by 6.7 percent; and PIT by by 1.3 pp y-o-y to 29.8 percent. Youth 10.9 percent, excise revenues by 6.4 percent, while customs duties will slightly decrease. A 5 Statistical discrepancy is distributed between consumption and slight underperformance in revenue, compared investment, while contribution from inventories are included in investment. to the plan, is expected, which will however 44  | Kosovo RISING UNCERTAINTIES be overcompensated with a significant under contribute to GDP beyond the construction execution of capital investment plans. The period; the second prime destination for FDI overall fiscal balance according to the fiscal rule was construction (12 percent).6 The main definition will be below the deficit ceiling of origin of FDI was Germany, Switzerland, and 2 percent of GDP, as it excludes PAK-financed the United States. Net remittances also grew by (privatization proceeds) capital spending and 8.1 percent in H1 compared to the same period the investment clause. By year end, public last year. By July 2019 goods exports had grown and publicly guaranteed debt is projected at by 10.5 percent y-o-y and net service exports by 17.7 percent of GDP. 17.3 percent, mainly driven by travel services to Kosovo’s diaspora. Imports of goods also grew Credit growth continues to be robust strongly at 4.9 percent y-o-y. because of high liquidity. As in 2018, better market conditions and lower interest rates led to higher private credit by end July. Corporate Outlook and Risks loans grew by 11 percent, particularly to such services as wholesale and trade and construction In the medium-term economic growth in and 11.9 percent to manufacturing; loans Kosovo is projected at about 4.2 percent, to households continued to grow fast at propelled by higher capital spending and 10.5 percent y-o-y at end July. The new loans to consumption. Several large public investment industry grew by 20 percent at end August. As projects are expected to advance, notably July ended, NPLs remained low at 2.5 percent railway and regional road projects financed by of total loans. international financial institutions (IFIs). In 2020 higher public wages, remittances, and Consumer price inflation accelerated early consumer lending are expected to support in the year but eased to 2.7 percent y-o-y by higher consumption. Private investment is August. The main cause was rising food prices, expected to increase, driven by favorable followed by a rise in the prices of alcoholic lending conditions and by FDI in energy and drinks and tobacco. The increase in import real estate. However, given the large number prices helped to push consumer price inflation, of new entrants into the labor market, higher with an average y-o-y increase of 4.5 percent public spending alone will not be sufficient in Q1. Tariffs imposed on goods imports from to significantly reduce the chronically high Serbia and Bosnia and Herzegovina may have unemployment. contributed to the rise in consumer price inflation. The positive outlook is vulnerable to domestic political uncertainty, lower than The current account deficit (CAD) is expected projected IFI-financed public investment, at 8.7 percent in 2019. Travel services, net FDI lower base metal prices than projected, (foreign direct investment) and remittances slower growth in the EU, and higher global continue to finance the trade deficit. Net FDI uncertainty. Moreover, the expansion of public rose by 50 percent y-o-y in the first half (H1) investment—the main driver of medium-term of 2019. However, most FDI continued to 6 The data on BoP is based on the data available at the time of the go to real estate (83 percent), which will not preparation of the reports, as of September 30, 2019. Kosovo  |  45 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 growth—may be limited by inadequate capacity to carry out the investment program which can result in the under-execution of spending. Headline fiscal policy is expected to be sustainable as long as fiscal risks are contained. The new law on public salaries, if not regulated through prudent secondary legislation, could result in higher deficits, a breach of the fiscal rule on public wage growth, and a deterioration in the composition of public spending. Similarly, if public employment is not contained through the 2020 could result in further increases in compensation of public employees. Because the law on public wages comes into force only at the end of 2019, the full impact will not be felt until 2020. Higher public sector wages can also put pressure on private sector wages, which could undermine the competitiveness of Kosovar exporters. Additional fiscal risks might arise from higher untargeted social protection spending, unproductive capital spending, and potentially lower performance of publicly owned enterprises To counterbalance the risks,  reforms should be directed to improving the quality of fiscal spending and stability; better targeting of social protection programs; investing more in education and health to realize the benefits of the demographic dividend and improve skills; engaging and employing youth and women by reducing disincentives to their participation in the labor market; heightening productivity by addressing the regulatory burden on businesses and improving the judicial system; addressing corruption; and building up environmental sustainability. 46  | Kosovo RISING UNCERTAINTIES Consumption is expected to be the main driver Services should continue to be a major of growth in 2019. contributor to growth on the production side in 2019, and beyond. Growth contributions, percent Growth contributions, percent 8 5 6 4 4 3 2 2 0 1 -2 -4 0 8 9 0 1 9 0 1 201 201 202 202 201 202 202 JJConsumption JJInvestments JJNet exports ▬▬Growth JJAgriculture JJIndustry JJServices ▬▬Real GDP growth Source: Statistics Agency of Kosovo and World Bank. Source: Statistics Agency of Kosovo and World Bank. Higher public investment through IFI and Net FDI increased in the first half of 2019, privatization proceeds-financed projects, and in comparison to the same period last year transfers will raise budget deficits. especially in real estate and construction. Percent of GDP Million euros, nominal 35 -2.6 200 -2.7 150 30 -2.8 100 -2.9 -2.9 -3.0 -3.0 50 25 -3.2 0 -3.1 -3.2 20 -3.2 -50 8 9 0 1 201 201 202 202 Jan–Jun 2017 Jan–Jun 2018 Jan–Jun 2019 ▬▬Public revenues ▬▬Public expenditure ▬▬Budget balance, rhs JJEquity other than JJReinvestment of earnings JJDebt instruments reinvestment of earnings Source: Ministry of Finance and World Bank. Source: Central Bank and World Bank. Labor force participation continues to be low. Consumer price inflation went up in the first half but is now slowing. Percent Percent y-o-y growth 45 4.0 3.5 40 3.0 2.5 35 2.0 1.5 30 1.0 25 0.5 0 20 -0.5 16 1 6 17 17 18 18 19 -17 y-17 -17 -18 y-18 -18 -19 y-19 Q1- Q3- Q1- Q3- Q1- Q3- Q1- Jan Ma Sep Jan Ma Sep Jan Ma ▬▬Participation rate total ▬▬Employment rate ▬▬Unemployment rate Source: Statistics Agency of Kosovo, LFS. Source: Central Bank. Kosovo  |  47 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 KOSOVO 2014 2015 2016 2017 2018 2019e 2020f 2021f Real GDP growth (percent) 1.2 4.1 4.1 4.2 3.8 4.0 4.2 4.1 Composition (percentage points): Consumption 3.8 2.5 4.7 1.5 5.7 3.8 5.0 4.6 Investment -1.4 2.9 2.1 1.5 2.1 1.1 2.1 1.6 Net exports -1.2 -1.3 -2.7 1.2 -3.8 -1.4 -1.3 -0.9 Exports 2.9 0.5 0.5 4.0 1.0 1.1 1.1 1.5 Imports (-) 4.1 1.8 3.2 2.8 4.8 2.5 2.5 2.4 Consumer price inflation (percent, period average) 0.4 -0.5 0.3 1.5 1.1 2.8 1.8 1.5 Public revenues (percent of GDP) 24.0 25.1 26.3 26.4 26.1 27.4 27.2 27.0 Public expenditures (percent of GDP) 26.6 27.1 27.7 27.6 29.1 30.3 30.4 30.0 Of which: Wage bill (percent of GDP) 8.7 9.0 9.0 8.6 8.8 8.7 8.7 8.7 Social benefits (percent of GDP) 5.0 5.4 6.1 6.1 6.2 6.4 6.2 6.3 Capital expenditures (percent of GDP) 7.4 7.0 7.2 7.3 7.9 7.8 8.4 8.6 Fiscal balance (percent of GDP) -2.6 -2.0 -1.4 -1.2 -3.0 -2.9 -3.2 -3.0 Primary fiscal balance (percent of GDP) -2.4 -1.7 -1.1 -0.9 -2.7 -2.5 -2.9 -2.7 Public debt (percent of GDP) 10.4 12.7 14.1 15.6 16.3 17.1 17.2 18.8 Public and publicly guaranteed debt 10.6 12.8 14.4 16.3 16.9 17.7 17.7 19.3 (percent of GDP) Of which: External (percent of GDP) 5.8 6.2 6.2 6.6 6.2 6.1 6.0 6.1 Goods exports (percent of GDP) 5.8 5.6 5.1 5.9 5.6 5.2 5.4 5.4 Goods imports (percent of GDP) 42.8 41.9 42.8 44.3 46.2 44.9 44.7 43.9 Net services exports (percent of GDP) 8.3 7.9 10.5 12.4 11.6 11.2 11.6 11.7 Trade balance (percent of GDP) -28.7 -28.5 -27.2 -26.1 -29.0 -28.6 -27.8 -26.8 Remittance inflows (percent of GDP) 11.2 11.5 11.4 11.8 10.7 10.2 9.9 9.9 Current account balance (percent of GDP) -6.9 -8.6 -7.9 -6.0 -8.0 -8.7 -8.3 -7.4 Net foreign direct investment inflows 2.2 4.7 2.9 3.4 2.8 3.8 4.1 4.2 (percent of GDP) External debt (percent of GDP) 31.2 33.3 33.2 32.6 33.7 33.8 34.5 34.2 Real private credit growth (percent, period average) 3.3 7.8 8.7 8.8 10.1 n.a. n.a. n.a. Nonperforming loans 8.5 6.2 4.9 3.1 2.7 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 35.3 32.9 27.5 30.5 29.5 n.a. n.a. .. Youth unemployment rate (percent, period average) 61.0 57.7 52.4 52.7 55.3 n.a. n.a. n.a. Labor force participation rate 41.6 37.6 38.7 42.8 40.9 n.a. n.a. n.a. (percent, period average) GDP per capita (US$) 4,055 3,745 3,692 3,818 4,312 4,377 4,667 4,934 Poverty rate at US$5/day, PPP 25.3 21.4 20.37 21.6 19.8 18.0 16.4 15.3 (percent of population) Sources: Country authorities, World Bank estimates and projections. Data on BOP payments if of September 30, 2019. 48  | Kosovo RISING UNCERTAINTIES Montenegro • After reaching 4.9 percent in 2018, the highest rate in 10 years, growth is expected to moderate in the near term as a large public investment cycle phases out.7 • Labor market developments remain positive, with employment rising and poverty declining. • Fiscal consolidation reduced the budget deficit but current spending was higher than planned. • Accelerating structural reforms and maintaining a prudent approach to public spending is critical because of limited fiscal space and rising global uncertainties. Recent Economic Developments in production of metal and mineral goods. In the first six months, recent construction growth Growth is expected to moderate as investment decelerated somewhat, to 12.3 percent y-o-y, levels off. After reaching 4.9 percent in the lowest since March 2016. 2018, the fastest rate in a decade, for 2019 economic growth is estimated at 3 percent. Employment is again rising steadily. Growth slowed in the first quarter because Supported by buoyant economic activity, of less investment and a decline in industrial the positive trend in employment growth production. It is projected, however, that continued, mostly in construction, tourism, private consumption—supported by favorable and other services. The survey-based labor market developments, increased lending, unemployment rate declined from 14.4 percent and booming tourism—will add 2.9 percentage in Q2 2018 to 14.3 percent in Q2 2019; it is points (pp) to economic growth. After delays projected to average 14.9 percent for the year. in public projects early in the year and a high Youth unemployment fell from 23.9 percent in base in 2018, investments are projected to Q2 2018 to a historic low of 20.7 percent in contribute 1.9 pp to growth in 2019. Because Q1 2019. There were also record highs in the those investments are import-dependent, survey-based participation rate of 57.8 percent the volume of imports is outpacing the solid and the employment rate of 49.5 percent. growth of exports. As a result, in 2019 net Yet long-term unemployment is still high: exports are projected to subtract 1.8 pp from 79 percent of unemployed workers have been growth. Recent economic activity indicators job-hunting for more than a year. As of July are mixed: By June, retail trade had grown 1, the government increased the net monthly by 5.3 percent year-on-year (y-o-y) and minimum wage from €193 to €222. At the tourist overnight stays were up 12.5 percent. same time, the health contribution paid by However, industrial production shrank by employers was reduced from 4.3 to 2.3 percent 12.2 percent as unfavorable hydrological to prevent a rise in unit labor costs and thus conditions early in the year impeded energy a potential adverse effect on employment. To production. Manufacturing growth also avoid employment losses, any further increase declined by 3.5 percent, led by a contraction in the minimum wage should be aligned with increases in labor productivity. 7 When this report was sent to print, the Statistical office of Montenegro published the final 2018 National Account data, according to which the rate of real GDP growth was 5.1 percent. Montenegro  |  49 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Inflation eased in the first half. Consumer Despite strong revenue growth, high current price inflation was just 0.5 percent, driven by spending resulted in a higher-than-planned declining prices for clothing, transportation, fiscal deficit. By June recent economic activity alcohol, and tobacco, though producer prices and higher tax compliance supported 8 percent rose by 2.4 percent, mainly driven by higher growth in central government revenues, prices for coal and mineral goods manufactures. and under-execution of capital spending Consumer price inflation is projected to be by 50 percent, also helped cut the deficit. 1 percent for the full year. In the first six months, Nevertheless, current spending rose because nominal wages increased by 0.6 percent, but of a 4 percent y-o-y increase in spending on real wages were flat. wages, in part due to a delay in reform of the public administration, and a 12 percent The current account deficit (CAD) is increase in transfers, primarily for spending on projected to hit 17.4 percent in 2019. health. High current spending delays the goal Solid growth of exports in the first half was of balancing the budget. led by tourism and transport services, but merchandise exports stalled because of lower The government is actively managing public aluminum and electricity exports. Import debt, but liabilities remain high. Over the growth was somewhat lower, driven by next two years debt amounting to €800 million electricity, minerals, and medical products; but is coming due. In September, the government since import volume is double export volume, issued a Eurobond of €500 million with an the trade deficit increased. Income accounts interest rate of 2.55 percent and a ten-year moderated due to interest and dividend maturity. The record-low interest rate and a payments. Net FDI picked up to 8.3 percent of record-long maturity are the results of fiscal GDP, financing about half of the CAD, the rest consolidation efforts undertaken, but also being covered by portfolio investment and by of the current favorable market conditions. loans. By June, foreign exchange reserves had Nevertheless, in the view of increasingly slipped to €0.8 billion, covering 3.9 months of uncertain environment, the government must merchandise imports. remain committed to fiscal consolidation and avoid any policy reversal. The government Since two banks were liquidated, the plans to use the 2019 Eurobond proceedings financial sector has been resilient. In the first to cover its financing needs for 2020, which half of 2019, deposits fell by 2.7 percent y-o-y includes repayment of Eurobonds due in while credits grew by 0.6 percent, driven by March. The Eurobonds will push public debt 8.9 percent growth in lending to households. to an estimated 78.6 percent and public and Liquidity is ample—the loan-to-deposit ratio is publicly guaranteed (PPG) debt to an estimated 90 percent. Continued credit growth helped to 83 percent by year-end. reduce non-performing loans to 5.3 percent of total loans. The June average capital adequacy ratio of 19.5 percent exceeded the regulatory minimum. The banking sector is moderately profitable, but profits are unevenly distributed among banks. 50  | Montenegro RISING UNCERTAINTIES Outlook and Risks launch of the economic citizenship program.8 Other financial sector vulnerabilities stem from The outlook is positive, but the uncertainty ailing second-tier banks. of the external environment is a major risk. The economy is expected to average 2.8 percent A firm commitment to structural reforms growth through 2021. The phasing-out of is critical. With global prospects uncertain the investment cycle that has driven growth and fiscal buffers limited, it is imperative for for three years is likely to continue to slow Montenegro to remain fully committed to fiscal growth somewhat, to 2.8 percent in 2020 consolidation, improvement in governance, and 2.7 percent in 2021. Completion of large and acceleration of structural reforms. In public infrastructure projects should reduce the this context, it is necessary to increase the CAD and the fiscal deficit, which is expected to efficiency of public spending, especially in turn to surplus in 2021. Thus in 2021 public administration, health, and infrastructure. debt is forecasted to decline to 62.3 percent of This necessitates resolving the unsustainability GDP and PPG debt to 66.6 percent. Private of the operations of Montenegro Airlines. investment is expected to remain high, mostly which has been granted significant state aid; driven by energy and tourism, but investment in 2018, its accumulated losses reached €90 sentiment could be affected by falling business million, exceeding its capital. At the same time, confidence and uncertainties in external fighting corruption and reinforcing the state markets. Unless there is a faster slowdown in institutions that protect the rule of law and EU demand, exports are expected to strengthen private sector competition would help unlock due to new energy and tourism capacities. An stronger, more equitable, and more sustainable unexpectedly strong global slowdown and growth, ensuring faster convergence with EU the associated uncertainties would weigh on income levels. growth and could limit the scope for robust improvements in the labor market and welfare. The domestic risks are mixed. Construction of the remaining phases of the Bar-Boljare highway within the forecast period would support growth but could also compromise fiscal consolidation. Financing through public- private partnerships, for example, can carry high contingent liabilities. which would push up PPG debt and narrow the fiscal space. Delay in optimizing the public administration could further undermine fiscal consolidation. However, completion of the airport concessions within the forecast period would result in additional one-time revenues, as would the 8 Since the airport concession agreement and the economic citizenship program are surrounded by uncertainty, these are considered an upside risk and are not included in the projections. Montenegro  |  51 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Growth slowed in the first quarter of 2019… …partly driven by base effect and a decline in industrial production. Contribution to growth, percentage points High-frequency data, trend-cycle, Jan 2014–Jul 19 20 6 200 last obs. 6/19 15 5 180 10 4 160 5 3 140 0 2 120 -5 -10 1 100 -15 0 80 I-17 III-1 7 I-18 III-1 8 I-19 -14 -14 -15 -15 -16 -16 -17 l-17 -18 -18 -19 Jan Jul Jan Jul Jan Jul Jan Ju Jan Jul Jan JJHousehold consumption JJGovernment consumption ▬▬Total industry_tc ▬▬Retail trade_tc JJGross investments JJNet exports ▬▬Real growth, rhs ▬▬Tourism_tc Source: MONSTAT data, World Bank staff calculations. Source: MONSTAT. Tc = Trend cycle. Employment growth remained strong… …and inflationary pressures eased. Administrative data, thousands, Jan 2012–Jun 2019 Jan 2014–Jun 2019, annual growth rates 220 55 4 50 3 200 45 2 190 40 1 180 35 0 30 170 -1 25 160 2 last obs. 6/19 20 -2 last obs. 7/19 -1 -13 -14 -15 -16 -17 -18 -19 -14 -14 -15 -15 -16 -16 -17 l-17 -18 -18 -19 -19 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jul Jan Jul Jan Jul Jan Ju Jan Jul Jan Jul ▬▬Employment ▬▬Employment_tc ▬▬CPI ▬▬PPI ▬▬Unemployment, rhs ▬▬Unemployment_tc, rhs Source: MONSTAT data, tc = trend cycle. Source: MONSTAT data. In 2019 the fiscal deficit is projected to be …with public debt estimated at about more than 3 percent of GDP in 2019… 78 percent of GDP. Percent of GDP, 2014–19 2014–19, percent of GDP 50 1 4 100 0 40 -1 80 3 -2 30 60 -3 2 -4 20 40 -5 -6 1 10 20 -7 0 -8 0 0 201 4 201 5 201 6 201 7 201 8 9e 201 4 201 5 201 6 201 7 8e 9f 201 201 201 JJTotal revenues and grants JJTotal expenditure and net lending JJGuarantees JJForeign public debt (EUR bn) ▬▬Cash deficit, % of GDP, rhs ▬▬Accrual deficit, % of GDP, rhs JJDomestic public debt (EUR bn) ▬▬Public debt, % of GDP, rhs Source: MOF and MONSTAT data. Source: MoF, CBCG, and MONSTAT data. 52  | Montenegro RISING UNCERTAINTIES MONTENEGRO 2014 2015 2016 2017 2018 2019e 2020f 2021f Real GDP growth (percent) 1.8 3.4 2.9 4.7 4.9 3.0 2.8 2.7 Composition (percentage points): Consumption 2.7 2.3 4.8 3.2 4.4 2.9 2.4 2.5 Investment 0.6 1.7 7.2 8.0 4.2 1.9 -0.4 -2.0 Net exports -1.6 -0.6 -9.1 -6.5 -3.7 -1.8 0.7 2.2 Exports -0.4 2.8 2.9 0.9 4.7 2.2 2.0 2.1 Imports (-) 1.2 3.4 12.0 7.4 8.4 4.0 1.3 -0.1 Consumer price inflation (percent, period average) -0.7 1.5 -0.3 2.4 2.6 1.0 1.6 1.8 Public revenues (percent of GDP) 44.6 41.5 42.5 41.4 42.4 43.0 42.5 41.3 Public expenditures (percent of GDP) 47.7 48.8 45.3 47.0 46.5 46.2 43.5 39.8 Of which: Wage bill (percent of GDP) 12.7 12.3 12.2 11.8 11.3 11.3 10.8 10.4 Social benefits (percent of GDP) 14.2 13.3 14.1 12.5 11.8 11.6 11.4 11.2 Capital expenditures (percent of GDP) 5.3 8.1 3.7 7.8 8.6 8.5 6.8 4.4 Fiscal balance (percent of GDP) -3.1 -7.3 -2.8 -5.7 -4.1 -3.2 -1.0 1.5 Primary fiscal balance (percent of GDP) -0.8 -4.9 -0.7 -3.3 -1.9 -1.1 1.1 3.5 Public debt (percent of GDP) 59.9 66.2 64.4 64.2 70.8 78.6 71.2 62.3 Public and publicly guaranteed debt 67.1 73.7 71.4 70.0 75.7 83.3 75.7 66.6 (percent of GDP) Of which: External (percent of GDP) 47.0 54.9 59.5 58.8 66.1 71.5 66.3 57.6 Goods exports (percent of GDP) 10.3 9.1 8.9 8.9 9.4 9.3 9.5 9.8 Goods imports (percent of GDP) 50.1 49.5 50.8 52.2 53.8 54.5 52.5 49.0 Net services exports (percent of GDP) 20.0 21.8 19.4 19.8 20.3 20.5 21.1 20.6 Trade and services balance (percent of GDP) -19.8 -18.6 -22.5 -23.5 -24.1 -24.7 -21.9 -18.6 Remittance inflows (percent of GDP) 4.7 4.4 4.0 3.9 4.1 4.1 4.0 3.9 Current account balance (percent of GDP) -12.4 -11.1 -16.2 -16.1 -17.2 -17.4 -15.3 -11.9 Net foreign direct investment inflows 10.2 17.1 9.4 11.3 7.0 8.0 8.0 8.0 (percent of GDP) External debt (percent of GDP) 162.9 169.4 162.6 160.6 164.4 180.0 178.5 175.6 Real private credit growth (percent, period average) -1.5 0.3 3.5 4.4 5.9 n.a. n.a. n.a. Nonperforming loans 16.8 13.4 11.1 8.0 7.7 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 18.0 17.6 17.7 16.1 15.2 14.9 14.7 14.8 Youth unemployment rate (percent, period average) 35.8 37.6 35.9 31.7 29.4 n.a. n.a. n.a. Labor force participation rate 52.7 53.7 54.5 54.7 56.0 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 15,371 16,337 17,867 19,355 21,071 21,914 23,015 24,010 Poverty rate at US$5.5/day, PPP 4.8 4.6 4.2 4.4 4.7 4.5 4.3 4.2 (percent of population) Sources: Country authorities, World Bank estimates and projections. Note: Nonperforming loans show year-to-date actuals (including interest and accruals). Montenegro  |  53 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 North Macedonia • Growth is firming up in 2019 and is projected to reach 3.1 percent by year-end, driven by rising investments and consumption. • Unemployment fell to a historic low and wage pressure continues, which may affect the competitiveness of the economy as unit labor costs rise. • Public debt and the fiscal deficit widened in 2019 as current spending increased due to rising wages, pensions, and subsidies amid moderate growth in revenues. • Staying on course with structural reforms that reignite competitiveness, improve governance, and public sector performance will help accelerate the process of income convergence with the EU. Recent Economic Developments for 2019 is expected to reach 3.1 percent, up from 2.7 percent in 2018. Growth is firming up in 2019. Economic growth strengthened in the first half of 2019 The labor market has continued improving. to 3.6 percent, its fastest rate since 2016. Employment went up by 5.2 percent y-o-y Wholesale and retail trade were the main in H1, after averaging 2.5 percent in 2018. driver of growth, accounting for 1.5 pp. Most of the new jobs were in manufacturing, Agriculture contributed 0.5 pp contributions, transport and storage, administrative services while industry contributed 0.4 pp despite a and entertainment. The employment rate slowdown in manufacturing, evident in Q2 improved to 47 percent—up an annualized 2019. Construction also added 0.1 pp, but 2.3 pp. Unemployment fell to 17.7 percent in this is expected to be temporary as surveys for H1, a historic low, and the participation rate the sector point to positive expectations from stayed at 57.1 percent. It is estimated that for companies in terms of contracts, prices and 2019 as a whole, unemployment will decline to employment. On the demand side, the main 19.4 percent. contributors to growth in the first half of 2019 were investment and private consumption, the Wage pressures again increased in 2019. By latter spurred by rising wages, pensions, and June real net wages were up over 2 percent household lending. Net exports subtracted y-o-y, partly because the minimum wage from growth for the second consecutive quarter: increased in both July 2018 and April 2019, rising exports were not enough to compensate and some public servants were given a raise in for the growing imports of intermediate, early 2019. The highest wage increases were capital, and consumer goods. While private in health, education, and social protection, consumption is expected to moderate by year- transport, construction, and agriculture. The end, investments will strengthen, partly due to continued trend of wage growth, particularly acceleration of public investments. However, in labor-intensive industries, coupled with a net exports are expected to continue subtracting decline in labor productivity in most sectors, from growth because rising exports will not be is jeopardizing the competitiveness of the enough to compensate for a surge in imports, economy as the unit cost of labor goes up. mainly capital and intermediary goods. Growth Using the US$5.5/day (2011 PPP) poverty 54  |  North Macedonia RISING UNCERTAINTIES line, it is projected that poverty is falling below credits also picked up by 4.4 percent, led by 21 percent for 2019, continuing a decreasing longer-term investment lending, indicating a trend that began in 2009. Using the $11/day pick-up in corporate activity. Despite credit (2005 PPP) line, the middle class increased growth, nonperforming loans (NPLs) by July from approximately 30 percent in 2009 to decreased slightly to 4.7 percent, with corporate about 41 percent in 2015. NPLs at 7.5 percent. At 10.1 percent deposits continued to rise y-o-y, resulting in a loan- The external imbalance somewhat widened to-deposit ratio of 82.5 percent. The survey in 2019. The current account deficit (CAD) of credit activity indicates a continued rise in is expected to broaden to 0.7 percent of GDP, lending, based on higher demand and easing of compared to 0.2 percent at year end 2018. credit requirements. In June, it stood at 1 percent of GDP (on a four-quarter rolling basis). The solid export Monetary policy was further relaxed. In early performance of FDI-related industries like 2019, the central bank lowered the key interest automobile parts and electrical machinery rate by 25 bps, to a historic low of 2.25 percent, continued and is being supplemented by based on favorable developments in the exports of iron and steel, largely because foreign exchange market, moderate inflation, of favorable terms of trade, and furniture continued solid deposit growth, and a negative and tobacco product exports. Despite rising output gap. Inflation for the year is expected imports of intermediary and capital goods to average 1.6 percent y-o-y because of higher and of consumption goods, the trade deficit food prices. is expected to decline to less than 15 percent of GDP. The surplus in net services exports is Despite a rise in tax and contribution rates, expected to increase somewhat, to 3.5 percent the fiscal deficit widened in 2019. In H1 of GDP, which with lower surpluses in transfers government revenues went up 6 percent y-o-y: and income is expected to result in a slightly higher rates for social contributions were higher CAD. FDI in the first half of 2019 introduced in January, the personal income dropped as profits were repatriated but is tax higher statutory rate was introduced, while expected to rebound in H2 to reach 3.2 percent exemptions were reduced, and tobacco excises of GDP for the full year. Gross foreign currency were increased. However, spending went up reserves will hold steady at above 4 months of by 8.4 percent y-o-y due to rising pensions, imports. For the year, external debt is projected wages, subsidies, and health spending. Capital to rise above 78 percent of GDP in 2019, due spending, although rising, is still vastly under- to the rise in public external debt. executed. The revised General Government 2019 deficit is projected at 2.5 percent of GDP Credit continued its robust growth in 2019 (the World Bank estimate stands at 2.4 percent), with a rise in corporate lending. Overall, up from 1.1 percent in 2018; when combined credit growth in July was 6.8 percent y-o-y, with the deficit of the Public Enterprise for State down from 7.3 percent at the end of 2018. Roads, the total deficit estimate is 2.7 percent. Growth in household credit remained robust at The budget revision led to a further increase in 9.4 percent y-o-y, accounting for 60 percent of subsidies for social contribution payments to total growth in credit. Corporate, non-public, incentivize formalization of wages paid in cash; North Macedonia  |  55 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 subsidies to agriculture; and a 15-percent paid due to lower capital spending, for the medium VAT refund to citizens, upon submission of tax term they should be offset with other spending receipts to strengthen tax compliance. Public or revenue measures to avoid increasing fiscal and publicly guaranteed debt is expected to vulnerabilities. While these efforts are intended rise from 48.5 percent in 2018 to 51 percent, to tackle informality, which is a major drag on as government borrowing intensifies to meet the economy, they are unlikely to be successful coming obligations and guaranteed debt unless they are accompanied by strengthening also goes up as public investment in roads of the tax administration, greater inspection accelerates. efficiency, and improvements in the delivery of public services and in laws affecting the business environment. Outlook and Risks Although 2019 is a pre-election year, possible The outlook for the economy is moderately opening of EU accession negotiations requires positive, with annual average growth that North Macedonia stay the course on predicted to be about 3.2 percent through structural reformsto reignite competitiveness, 2021. Investment (e.g., public investment in improve governance, and enhance public sector the highway, and private investment in energy performance. Invigorating competition policy and tourism) will be the main driver of growth. and rationalizing state aid would promote both It will be supported by personal consumption growth and fiscal sustainability. as employment picks up and wages continue to grow, propelled by a higher minimum wage that will mostly affect private sector employees. Net-exports are expected to subtract from growth as external demand weakens somewhat. This baseline scenario is accompanied by rising risks, in particular external, as there are increasing signs of a slowdown in the EU and the global economy, affected by the trade dispute between the US and China, the Brexit uncertainty, tensions between US and Iran, crises in emerging economies like Argentina etc. Fiscal consolidation is expected to continue, even though more slowly due to new spending programs. The government has introduced two programs to fight informality, which is estimated at 30–40 percent of GDP, the annual cost of which is estimated at 0.8 percent of GDP. While these programs have been accommodated within the 2019 planned deficit 56  |  North Macedonia RISING UNCERTAINTIES Economic growth accelerated in 2019… ...although with signs of moderation by mid- year. Percent 2011=100, trade cycle, percent 6 160 300 140 250 4 120 200 2 100 80 150 0 60 100 40 -2 50 20 -4 0 0 16 6 17 7 18 8 19 0 1 2 3 4 5 6 7 8 Q1- Q3- 1 Q1- Q3- 1 Q1- Q3- 1 Q1- 201 201 201 201 201 201 201 201 201 JJAgriculture JJMining, electricity, gas supply JJManufacturing ▬▬Industry_tc ▬▬Retail trade_tc ▬▬Tourism_tc ▬▬Construction_tc, rhs JJConstruction JJWholesale & retail, transportation, accomodation JJOther services ▬▬Real GDP growth Source: State Statistics Office. Source: State Statistics Office and World Bank calculations. The external deficit widened but remained low. Solid growth reduced unemployment to a historic low. Percent of GDP Percent 30 70 35 20 60 30 50 25 10 40 20 0 30 15 -10 20 10 -20 10 5 -30 0 0 1 2 3 4 5 6 7 8 9 12 13 14 15 16 17 18 19 201 201 201 201 201 201 201 201 201 Q1- Q1- Q1- Q1- Q1- Q1- Q1- Q1- JJServices trade balance JJIncome JJGoods trade balance JJActivity rate JJEmployment rate JJCurrent transfers ▬▬Current account balance, rhs ▬▬Unemployment rate, rhs Source: National Bank. Source: State Statistics Office. Lending to corporations rose as monetary …and public debt is projected to increase as policy relaxed… the fiscal deficit widened. Percent, and RHS: yearly change, percent Percent of GDP 100 10 50 90 80 8 40 70 60 6 30 50 40 4 20 30 20 2 10 10 0 0 0 16 1 6 17 1 7 18 18 19 2 4 6 8 0 2 4 6 8 Q1- Q3- Q1- Q3- Q1- Q3- Q1- 200 200 200 200 201 201 201 201 201 JJContribution of household loans JJContribution of corporate loans JJDomestic debt JJForeign debt JJGuarantees ▬▬Credit growth, rhs Source: National Bank. Source: Ministry of Finance and World Bank estimates. North Macedonia  |  57 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 NORTH MACEDONIA 2014 2015 2016 2017 2018 2019e 2020f 2021f Real GDP growth (percent) 3.6 3.9 2.8 0.2 2.7 3.1 3.2 3.3 Composition (percentage points): Consumption 2.1 3.5 2.0 0.1 3.2 2.0 1.9 1.8 Investment 2.8 2.9 3.9 0.7 -2.2 1.2 1.5 1.7 Net exports -1.3 -2.5 -3.2 -0.5 1.7 -0.1 -0.2 -0.2 Exports 7.3 4.2 4.7 4.5 9.1 5.4 5.6 6.0 Imports (-) 8.6 6.7 7.9 5.0 7.4 5.5 5.8 6.2 Consumer price inflation (percent, period average) -0.2 -0.3 -0.2 1.3 1.4 1.6 1.8 2.0 Public revenues (percent of GDP) 29.7 31.0 30.6 31.0 30.4 32.0 32.0 32.0 Public expenditures (percent of GDP) 33.9 34.4 33.2 33.9 31.5 34.4 34.8 34.4 Of which: Wage bill (percent of GDP) 7.0 7.0 6.8 6.6 6.3 6.5 6.4 6.1 Social benefits (percent of GDP) 14.9 14.8 15.0 15.4 15.2 15.6 15.7 15.4 Capital expenditures (percent of GDP) 4.2 4.2 3.8 4.2 2.5 3.5 4.0 4.1 Fiscal balance (percent of GDP) -4.2 -3.4 -2.7 -2.7 -1.1 -2.4 -2.8 -2.4 Overall Fiscal Balance with the Public Enterprise -5.3 -4.1 -3.8 -3.5 -1.7 -2.7 -3.4 -2.7 for State Roads* Primary fiscal balance (percent of GDP) -3.2 -2.3 -1.5 -1.5 0.1 -1.1 -1.6 -1.1 Public debt (percent of GDP) 38.1 38.1 39.9 39.5 40.5 43.4 44.5 43.8 Public and publicly guaranteed debt 45.8 46.6 48.8 47.8 48.5 51.1 52.4 52.2 (percent of GDP) Of which: External (percent of GDP) 32.1 31.6 34.2 32.0 32.9 35.1 36.6 34.9 Goods exports (percent of GDP) 25.7 26.8 35.1 38.1 43.2 41.6 45.4 47.3 Goods imports (percent of GDP) 42.9 42.9 53.1 54.9 58.6 56.1 60.8 62.3 Net services exports (percent of GDP) 4.5 3.8 3.5 3.8 3.3 3.5 3.8 4.1 Trade balance (percent of GDP) -12.7 -12.2 -14.5 -13.0 -12.1 -11.0 -11.6 -10.9 Remittance inflows (percent of GDP) 2.4 2.3 2.0 1.9 1.9 1.9 1.9 1.9 Current account balance (percent of GDP) -0.5 -2.0 -2.9 -1.0 -0.3 -0.7 -1.2 -1.0 Net foreign direct investment inflows 2.3 2.2 3.3 1.8 5.8 3.2 3.7 4.0 (percent of GDP) External debt (percent of GDP) 70.0 69.3 74.7 73.6 73.7 78.1 78.7 77.4 Real private credit growth (percent, period average) 8.6 9.5 4.3 1.2 5.1 n.a. n.a. n.a. Nonperforming loans 10.8 10.3 6.3 6.1 5.1 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 28.0 26.1 23.7 22.4 20.7 19.4 18.0 17.0 Youth unemployment rate (percent, period average) 53.1 47.3 48.2 46.7 45.4 n.a. n.a. n.a. Labor force participation rate 57.3 57.0 56.5 56.8 56.9 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 22,002 22,514 22,998 23,493 23,998 24,514 25,041 25,579 Poverty rate at US$5/day, PPP 24.8 23.2 21.9 21.0 20.7 20.5 20.5 20.2 (percent of population) Sources: Country authorities, World Bank estimates and projections. Note: Poverty rates are based on North Macedonia survey on income and living conditions (SILC). 58  |  North Macedonia RISING UNCERTAINTIES Serbia • Growth in 2019 is currently projected at 3.3 percent, lower than expected due to the unfavorable external situation. • External imbalances are widening: The CAD is projected to reach 6.7 percent of GDP in 2019 as momentum softens in Serbia’s main trading partners. • A surplus of 0.3 percent of GDP in the general government budget in the first half of 2019 helped to reduce public debt and could lead to the projected deficit being revised to a small surplus. • The recent slowdown of the economy could be exacerbated if external conditions for emerging markets tighten, EU growth slows, and local and regional political uncertainty worsens. Recent Economic Developments The performance of industry was disappointing, and early indicators also The Serbian economy expanded by 2.8 percent suggest a modest agricultural season. in the first half of 2019 (H1), which makes Industrial output fell by 2 percent in H1— difficult to reach originally projected annual manufacturing alone saw output fall by growth of 3.5 percent. Based on the latest 2.8 percent. The decrease in industrial output estimates by the Statistics Office year-on- was broad-based, occurring in 17 of 29 sectors. year (y/y) growth was below expectations at As for agriculture, production of wheat could 2.7 percent in Q1 and 2.9 percent in Q2. As be down around 14 percent from last year, as a result, the growth projection for the year has well as of fruit: in H1 production of raspberries been lowered to 3.3 percent. Consumption and cherries was significantly smaller. On the and investment, though strong, will not be other hand, production of corn and other sufficient to compensate for an increasing important products turned out to be better negative contribution of net exports to growth, than previously expected. It is now estimated as exports slows down. Higher consumption, that agriculture would have a zero contribution both public and private, is to a large extent to growth in 2019 (unlike previously projected being met by increased imports. In H1 imports negative contribution). In addition, services of goods and services rose 12.2 percent (in euro have been performing briskly. Retail trade terms), a development expected to continue till turnover was 8.5 percent higher in real terms yearend. Investment has remained high, driven in H1 than a year earlier. Tourism saw a by general government investment, which rose 4.3 percent rise in arrivals, and transport of by 31 percent in nominal terms. This year’s goods went up 3.3 percent,9 primarily because lower-than-expected growth to date is mainly more goods travelled by road. a result of export growth slowing as economic activity moderated in Serbia’s major trading Labor market improvement continues, but partners, particularly Italy and to some extent more slowly. According to Labor Force Survey in Germany. data, in H1 unemployment again fell, to an estimated 11.2 percent. Official data (based 9 The first quarter data. Serbia  |  59 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 on the Central Registry of Mandatory Social Inflation has been declining in recent Insurance and National Employment Services months, after peaking in April at 3.1 percent registries) confirm improvements in the labor y/y. The main driver of inflation in H1 market. Thus, registered employment rose by was food prices, which peaked in April at 2.4 percent in H1 (y/y) and average wages also 6.1 percent y/y. With inflationary pressures went up, in nominal terms by 9.9 percent and low and the inflation outlook stable, to boost in real terms by 7.2 percent.10 Wage growth growth NBS, the central bank, lowered its was higher in the private sector (10.7 percent) policy rate to 2.75 percent in July and to than in the public sector (9.5 percent), but the 2.5 percent in August—its lowest level since public sector wage premium remains: In H1 inflation targeting was introduced. In 2019, the average net wage in the public sector was the dinar continued to appreciate gradually. In 60,839 dinars, but just 51,145 dinars in the nominal terms, since 2018 it has appreciated private sector. by 0.4 percent against the euro.12 To smooth excessive short-term exchange rate volatility, The consolidated general government the NBS intervenes regularly in the foreign budget showed a surplus of 0.3 percent exchange market. So far this year it has been a of GDP in H1, y/y. Total revenues went up net purchaser of foreign currency, buying EUR by 7.6 percent in nominal terms. The main 1.6 billion, which by August helped to bring sources of higher public revenues were VAT Serbia’s foreign currency reserves to a record and social contributions. VAT revenues were high of EUR 13.1 billion, up EUR 1.8 billion up by 8.9 percent in nominal terms primarily since December 2018. Reserves currently cover because of higher collection of VAT from about six months of imports. imports, which went up significantly in 2019. Social security contributions rose by 8.1 percent Credit activity continues to be strong, but its because of the wage increase and the move to structure is somewhat unfavorable. Overall, more formal employment. Budgetary spending through July credit grew by 6.9 percent y/y, rose by 9.6 percent in nominal terms, equal primarily because of loans to businesses (up to 1.7 percent of annual GDP. The main 10.3 percent y/y). While loans to private drivers of higher spending were social transfers businesses were up by (a still strong) 8.4 percent, (including pensions), up by 6.6 percent; capital loans to state-owned enterprises (SOEs) investments, up 30.7 percent; and the wage increased by 32.8 percent, although from a bill, up 8.3 percent. The fiscal surplus reached low base. Loans to households also continued 0.3 percent of annual GDP—half what it was to rise. Many household loans are short-term in the same period of 2018. Throughout H1, “cash” loans to individuals; the stock of those the surplus and GDP growth helped to keep loans is 15.8 percent higher in euro terms than a public and publicly guaranteed debt broadly year ago. Another factor raising questions about stable at around 54 percent of GDP.11 loan portfolio structure is that loans to private enterprises were just 4 percent higher than loans to households. Finally, 47 percent of the new loans were for liquidity purposes (current 10 Data available through May only. assets) and only 35 percent for investment. 11 Total public debt includes nonguaranteed debt of local governments. 12 Data as of end-August. 60  | Serbia RISING UNCERTAINTIES Moreover, in H1 local banks provided no loans Outlook and Risks for export purposes. And 61.5 percent of the new loans went to SMEs. Growth of the Serbian economy in 2019 is expected to be slightly lower than previously The banking system is performing well. projected but over the medium term to Gross nonperforming loans (NPLs) declined recover to about 4 percent. Economic activity considerably, to 5.2 percent in June.13 The NPLs is projected to grow by 3.3 percent because of households were even lower at 4.4 percent. external developments are less favorable. Also, NPLs total about EUR 1 billion, of which a shift to consumption-led growth has pushed about EUR 400 million is owed by active up imports, which coupled with lower exports businesses and EUR 200 million by enterprises due to economic downturns in major trading now in bankruptcy proceedings. The value of partners (Italy in particular) means that the household NPLs is about EUR 400 million. negative contribution to growth of net exports NPLs are expected to continue to decline over will be higher. Most recently, the announced the medium term, although not as fast as in the increase in public sector wages15, might even past two years. more contribute to this unfavorable shift in drivers of growth. In addition, this policy The current account deficit (CAD) went up measure will certainly make the effort of considerably in 2019. In euro terms, in H1 keeping fiscal balance unchanged much more the CAD expanded by 51 percent y/y. Most difficult and will increase the deficit. Return to of the rise is explained by the widening of the more robust growth rates is expected only over trade deficit by 16 percent. Exports of goods the medium-term. rose by 8.5 percent, but imports went up by 10.2 percent, and from a much higher base. The medium-term growth projections The surplus in trade in services was lower by depend heavily on the speed of structural 2.4 percent. Net primary income is down by reform. Serbia has a large unreformed public 2.5 percent, y/y, and net secondary income sector with severe SOE inefficiencies. Also, by 7.4 percent, to a large extent because legal and institutional bottlenecks still prevent remittances were 4.3 percent lower. Therefore, faster development of the private sector and the projection for the 2019 CAD has risen to discourage higher investment, both foreign 6.7 percent of GDP. Still, the inflow of FDI and domestic. Among the needed reforms are is strong (€1.8 billion in H1, up 28 percent, upgrading regulation of the financial sector as y/y), and more than sufficient to finance the it relates to international capital and financial CAD. Total external debt has begun to go up transactions, leasing and fintech; providing in nominal terms, reaching EUR 27.1 billion support to SMEs to innovate and integrate in Q1, but is declining as a share of GDP, by into international value chains; relieving April reaching an estimated 62.5 percent.14 cumbersome and nontransparent taxation of SMEs; and trade facilitation, especially border controls. For the short term the main downside risk relates to election campaign and how quickly a new government is formed. 13 Preliminary figures. 14 The latest available data. 15 As announced in September 2019. Serbia  |  61 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Growth has begun to slow, as indicated by However, the labor market has improved. industrial activity. Change from same month previous year, percent Unemployment rate 12 16 10 14 8 12 6 4 10 2 8 0 6 -2 4 -4 -6 2 -8 0 -17 y-17 -17 -18 y-18 -18 -19 y-19 17 17 17 17 18 18 18 18 19 19 Jan Ma Sep Jan Ma Sep Jan Ma Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- Source: Statistics Office of Serbia. Source: Statistics Office of Serbia. Credit recovered, mainly because loans to However, short-term loans may be rising too households increased. fast. € billion Stock of loans, € billion 10,000 4,000 9,000 3,500 8,000 3,000 7,000 6,000 2,500 5,000 2,000 4,000 1,500 3,000 1,000 2,000 1,000 500 0 0 -15 Jul-15 an-16 Jul-16 an-17 Jul-17 an-18 Jul-18 an-19 Jul-19 -15 Jul-15 an-16 Jul-16 an-17 Jul-17 an-18 Jul-18 an-19 Jul-19 Jan J J J J Jan J J J J ▬▬Private enterprises ▬▬Government ▬▬Households ▬▬SOEs ▬▬Cash loans ▬▬Housing Source: National Bank of Serbia. Source: National Bank of Serbia. The CAD is widening rapidly. High FDI fully covers the CAD and is helping to push up reserves. 12-month cumulative, percent of GDP € billion 0 14,000 -2 12,000 -4 10,000 -6 8,000 -8 6,000 -10 4,000 -12 2,000 -14 0 -15 -15 -15 -16 -16 -16 -17 -17 -17 -18 -18 -18 -19 -19 -15 -15 -15 -16 -16 -16 -17 -17 -17 -18 -18 -18 -19 -19 Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May ▬▬Trade balance ▬▬CAB Source: National Bank of Serbia. Source: National Bank of Serbia. 62  | Serbia RISING UNCERTAINTIES SERBIA 2014 2015 2016 2017 2018 2019e 2020f 2021f Real GDP growth (percent) -1.6 1.8 3.3 2.0 4.2 3.3 3.9 4.0 Composition (percentage points): Consumption 0.1 -1.0 1.1 1.9 2.9 4.4 5.2 2.9 Investment -0.9 0.8 0.4 2.2 3.4 1.9 1.3 1.1 Net exports -0.8 1.9 1.9 -2.1 -2.0 -3.1 -2.7 -0.1 Exports 1.7 4.0 5.4 4.0 4.6 2.2 2.1 4.9 Imports (-) 2.5 2.0 3.5 6.1 6.6 5.2 4.8 5.0 Consumer price inflation (percent, period average) 2.1 1.4 1.1 3.2 2.0 2.2 1.9 2.5 Public revenues (percent of GDP) 39.0 39.3 40.8 41.5 41.1 40.8 40.1 39.8 Public expenditures (percent of GDP) 45.2 42.7 41.9 40.4 40.6 41.2 40.7 40.4 Of which: Wage bill (percent of GDP) 11.0 9.7 9.2 9.0 9.2 9.4 9.3 9.3 Social benefits (percent of GDP) 16.7 16.5 15.8 15.1 14.7 14.6 14.4 14.3 Capital expenditures (percent of GDP) 2.3 2.7 3.1 2.8 3.6 4.2 4.3 4.2 Fiscal balance (percent of GDP) -6.2 -3.4 -1.2 1.1 0.5 -0.4 -0.5 -0.5 Primary fiscal balance (percent of GDP) -3.4 -0.4 1.7 3.6 2.6 1.6 1.4 1.4 Public debt (percent of GDP) 58.2 64.0 62.8 55.6 50.1 49.1 46.0 43.0 Public and publicly guaranteed debt 65.4 70.6 68.6 58.7 54.3 52.1 49.2 46.3 (percent of GDP) Of which: External (percent of GDP) 39.0 42.4 42.7 35.5 33.6 38.1 35.9 33.8 Goods exports (percent of GDP) 30.0 32.1 34.9 35.9 35.5 35.0 34.2 34.1 Goods imports (percent of GDP) 41.6 42.3 43.4 46.1 47.7 50.3 51.6 49.7 Net services exports (percent of GDP) 1.3 2.0 2.5 2.4 2.5 4.3 4.8 3.9 Trade balance (percent of GDP) -10.3 -8.2 -6.0 -7.8 -9.7 -10.9 -12.6 -11.7 Remittance inflows (percent of GDP) 5.3 5.8 5.1 5.2 5.9 5.2 5.2 4.9 Current account balance (percent of GDP) -5.6 -3.5 -2.9 -5.2 -5.2 -6.7 -8.0 -7.7 Net foreign direct investment inflows 3.5 5.1 5.2 6.2 7.4 6.2 6.0 5.8 (percent of GDP) External debt (percent of GDP) 72.4 73.5 72.1 68.9 61.3 58.7 55.6 52.4 Real private credit growth (percent, period average) -3.8 -1.2 5.0 1.9 3.7 n.a. n.a. n.a. Nonperforming loans 21.5 21.6 17.0 9.8 5.7 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 19.2 17.7 15.3 13.5 12.7 12.0 11.8 11.7 Youth unemployment rate (percent, period average) 47.5 43.2 34.9 31.9 29.8 n.a. n.a. n.a. Labor force participation rate 51.9 51.6 53.3 54.0 54.5 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 14,435 14,925 15,674 16,386 17,555 18,567 19,792 21,096 Poverty rate at US$5.5/day, PPP 24.1 24.0 23.1 22.4 21.7 20.9 19.7 0.0 (percent of population) Sources: Country authorities, World Bank estimates and projections. Note: Nonperforming loans show year-to-date actuals. Serbia  |  63 Key Economic Indicators WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 Key Economic Indicators 2014 2015 2016 2017 2018 2019e 2020f 2021f Real GDP growth (percent) Albania 1.8 2.2 3.3 3.8 4.1 2.9 3.4 3.6 Bosnia and Herzegovina 1.1 3.1 3.1 3.2 3.6 3.1 3.4 3.9 Kosovo 1.2 4.1 4.1 4.2 3.8 4.0 4.2 4.1 North Macedonia 3.6 3.9 2.8 0.2 2.7 3.1 3.2 3.3 Montenegro 1.8 3.4 2.9 4.7 4.9 3.0 2.8 2.7 Serbia -1.6 1.8 3.3 2.0 4.2 3.3 3.9 4.0 WB6 0.4 2.6 3.3 2.6 3.9 3.2 3.6 3.8 Consumer price inflation (percent, period average) Albania 1.6 1.9 1.3 2.0 2.1 1.5 2.7 2.9 Bosnia and Herzegovina -0.9 0.0 -1.6 0.8 1.4 0.8 0.8 0.6 Kosovo 0.4 -0.5 0.3 1.5 1.1 2.8 1.8 1.5 North Macedonia -0.2 -0.3 -0.2 1.3 1.4 1.6 1.8 2.0 Montenegro -0.7 1.5 -0.3 2.4 2.6 1.0 1.6 1.8 Serbia 2.1 1.4 1.1 3.2 2.0 2.2 1.9 2.5 WB6 1.0 0.9 0.4 2.2 1.8 1.8 1.8 2.0 Public expenditures (percent of GDP) Albania 32.3 30.9 29.6 29.8 29.4 29.6 29.4 29.2 Bosnia and Herzegovina 45.8 42.5 41.5 40.4 40.6 42.4 41.4 40.3 Kosovo 26.6 27.1 27.7 27.6 29.1 30.3 30.4 30.0 North Macedonia 33.9 34.4 33.2 33.9 31.5 34.4 34.8 34.4 Montenegro 47.7 48.8 45.3 47.0 46.5 46.2 43.5 39.8 Serbia 45.2 42.7 41.9 40.4 40.6 41.2 40.7 40.4 WB6 38.6 37.7 36.5 36.5 36.3 37.4 36.7 35.7 Public revenues (percent of GDP) Albania 26.3 26.4 27.6 27.7 27.6 27.3 27.4 27.5 Bosnia and Herzegovina 43.7 43.1 42.7 43.0 42.8 41.8 42.0 41.7 Kosovo 24.0 25.1 26.3 26.4 26.1 27.4 27.2 27.0 North Macedonia 29.7 31.0 30.6 31.0 30.4 32.0 32.0 32.0 Montenegro 44.6 41.5 42.5 41.4 42.4 43.0 42.5 41.3 Serbia 39.0 39.3 40.8 41.5 41.1 40.8 40.1 39.8 WB6 34.5 34.4 35.1 35.2 35.1 35.4 35.2 34.9 Source: World Bank calculations and projections on data from national authorities and World Economic Outlook (2017) 66  | Key Economic Indicators RISING UNCERTAINTIES 2014 2015 2016 2017 2018 2019e 2020f 2021f Fiscal balance (percent of GDP) Albania -6.0 -4.5 -1.8 -2.0 -1.8 -2.2 -2.0 -1.7 Bosnia and Herzegovina -2.0 0.7 2.6 2.6 2.2 -0.6 0.6 1.4 Kosovo -2.6 -2.0 -1.4 -1.2 -3.0 -2.9 -3.2 -3.0 North Macedonia -4.2 -3.4 -2.7 -2.7 -1.1 -2.4 -2.8 -2.4 Montenegro -3.1 -7.3 -2.8 -5.7 -4.1 -3.2 -1.0 1.5 Serbia -6.2 -3.4 -1.2 1.1 0.5 -0.4 -0.5 -0.5 WB6 -4.0 -3.3 -1.2 -1.3 -1.2 -2.0 -1.5 -0.8 Public debt (percent of GDP) Albania 66.1 69.1 68.7 67.8 64.6 63.0 62.1 59.6 Bosnia and Herzegovina 41.6 41.9 42.3 36.1 34.1 33.2 32.3 31.4 Kosovo 10.4 12.7 14.1 15.6 16.3 17.1 17.2 18.8 North Macedonia 38.1 38.1 39.9 39.5 40.5 43.4 44.5 43.8 Montenegro 59.9 66.2 64.4 64.2 70.8 78.6 71.2 62.3 Serbia 58.2 64.0 62.8 55.6 50.1 49.1 46.0 43.0 WB6 45.7 48.7 48.7 46.4 46.1 47.4 45.6 43.1 Public and publicly guaranteed debt (percent of GDP) Albania 72.0 72.7 72.3 71.9 69.7 68.4 66.6 64.3 Bosnia and Herzegovina 43.4 43.6 42.1 37.7 35.6 34.6 33.7 32.7 Kosovo 10.6 12.8 14.4 16.3 16.9 17.7 17.7 19.3 North Macedonia 45.8 46.6 48.8 47.8 48.5 51.1 52.4 52.2 Montenegro 67.1 73.7 71.4 70.0 75.7 83.3 75.7 66.6 Serbia 65.4 70.6 68.6 58.7 54.3 52.1 49.2 46.3 WB6 50.7 53.4 52.9 50.4 50.1 51.2 49.2 46.9 Goods exports (percent of GDP) Albania 9.3 7.5 6.7 6.9 7.7 5.5 5.7 5.9 Bosnia and Herzegovina 25.0 25.2 25.7 29.8 30.2 28.7 28.7 28.5 Kosovo 5.8 5.6 5.1 5.9 5.6 5.2 5.4 5.4 North Macedonia 25.7 26.8 35.1 38.1 43.2 41.6 45.4 47.3 Montenegro 10.3 9.1 8.9 8.9 9.4 9.3 9.5 9.8 Serbia 30.0 32.1 34.9 35.9 35.5 35.0 34.2 34.1 WB6 23.0 23.6 25.8 27.3 27.9 26.9 27.0 27.2 Source: World Bank calculations and projections on data from national authorities and World Economic Outlook (2017) Key Economic Indicators  |  67 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.16 2014 2015 2016 2017 2018 2019e 2020f 2021f Trade balance (percent of GDP) Albania -19.0 -17.3 -16.8 -15.1 -13.8 -14.5 -14.4 -13.9 Bosnia and Herzegovina -22.7 -18.5 -16.7 -16.3 -15.2 -15.4 -16.2 -17.1 Kosovo -28.7 -28.5 -27.2 -26.1 -29.0 -28.6 -27.8 -26.8 North Macedonia -12.7 -12.2 -14.5 -13.0 -12.1 -11.0 -11.6 -10.9 Montenegro -19.8 -18.6 -22.5 -23.5 -24.1 -24.7 -21.9 -18.6 Serbia -10.3 -8.2 -6.0 -7.8 -9.7 -10.9 -12.6 -11.7 WB6 -15.8 -13.8 -12.9 -13.2 -13.7 -14.3 -15.0 -14.4 Current account balance (percent of GDP) Albania -10.8 -8.6 -7.6 -7.5 -6.7 -7.0 -6.4 -6.1 Bosnia and Herzegovina -7.3 -5.3 -4.7 -4.7 -4.3 -4.5 -5.3 -6.0 Kosovo -6.9 -8.6 -7.9 -6.0 -8.4 -8.7 -8.3 -7.4 North Macedonia -0.5 -2.0 -2.9 -1.0 -0.3 -0.7 -1.2 -1.0 Montenegro -12.4 -11.1 -16.2 -16.1 -17.2 -17.4 -15.3 -11.9 Serbia -5.6 -3.5 -2.9 -5.2 -5.2 -6.7 -8.0 -7.7 WB6 -6.4 -5.1 -4.9 -5.5 -5.4 -6.3 -6.8 -6.5 External debt (percent of GDP) Albania 69.5 74.4 73.5 68.7 62.9 60.6 59.9 56.3 Bosnia and Herzegovina 76.3 72.2 72.2 68.5 66.1 65.8 65.8 65.5 Kosovo 31.2 33.3 33.2 32.6 33.7 33.8 34.5 34.2 North Macedonia 70.0 69.3 74.7 73.6 73.7 78.1 78.7 77.4 Montenegro 162.9 169.4 162.6 160.6 164.4 180.0 178.5 175.6 Serbia 72.4 73.5 72.1 68.9 61.3 58.7 55.6 52.4 WB6 80.4 82.0 81.4 78.8 77.0 79.5 78.8 76.9 Unemployment rate (period average, percent) Albania 17.5 17.1 15.2 13.7 12.3 11.5 n.a. n.a. Bosnia and Herzegovina 27.5 27.7 25.4 20.5 18.4 15.7 n.a. n.a. Kosovo 35.3 32.9 27.5 30.5 29.5 n.a. n.a. .. North Macedonia 28.0 26.1 23.7 22.4 20.7 19.4 18.0 17.0 Montenegro 18.0 17.6 17.7 16.1 15.2 14.9 14.7 14.8 Serbia 19.2 17.7 15.3 13.5 12.7 12.0 11.8 11.7 WB6 24.3 23.2 20.8 19.5 18.1 14.7 14.8 14.5 Source: World Bank calculations and projections on data from national authorities and World Economic Outlook (2017) 68  | Key Economic Indicators Western Balkans Regular Economic Report No.16 | Fall 2019 View this report online: www.worldbank.org/eca/wbrer Angel Profiles by Eduart Karaj Eduart Karaj has fifteen years of experience in panting and sculpting. Karaj graduated at the Academy of Arts in Tirana in 2005. His works have been displayed in a number of personal and collective exhibitions of both genres in Albania and abroad. He also does icon restoration including a multi- year assignment in the Orthodox Christian Church in Tirana. Karaj won Second Prize in the Ikonografi Moderne (Modern Iconography) Exhibition in Tirana in 2018. In a constant effort for enriching his art, Karaj’s oeuvre is characterized by a modern spirit, proof of which we can see also see in the painting he submitted to the Art Competition organized by the World Bank Tirana Office in Spring 2019. People forge ideas, people mold dreams, and people create art. To connect local artists to a broader audience, the cover of this report and following editions will feature art from the Western Balkan countries.