Europe and Central Asia Economic Update Office of the Regional Chief Economist October 2015 WORLD BANK ECA ECONOMIC UPDATE OCTOBER 2015 Low Commodity Prices and Weak Currencies Office of the Chief Economist © 2015 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 18 17 16 15 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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ISBN (electronic): 978-1-4648-0753-4 DOI: 10.1596/978-1-4648-0753-4 Cover illustration is based on artwork of Serge Maksimov, Russian Federation Contents Acknowledgments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi PART I: Economic Outlook. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1  Fragile Recovery in the West, Difficult Adjustments in the East . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Acceleration in the West. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Contraction in the East . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 ECA Countries in Crisis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 The External Environment has Raised Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 2  Oil Prices and Real Exchange Rates. . . . . . . . . . . . . . . . . . . . . . . 21 Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Dutch Disease in a Nutshell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Empirical Evidence of (Reversed) Dutch Disease . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Simulating the Impact of Oil Prices on Inequality. . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 PART II: Country Pages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Albania . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Armenia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Azerbaijan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Belarus. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Bosnia and Herzegovina. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Bulgaria. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Croatia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Czech Republic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 iii iv  ●   World Bank ECA Economic Update October 2015 Georgia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Hungary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Kazakhstan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Kosovo. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Kyrgyz Republic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Macedonia FYR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Moldova . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Montenegro. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Poland. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Romania. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Russian Federation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Serbia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Slovak Republic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 Slovenia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 Tajikistan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Turkey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Uzbekistan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Boxes 1.1 How to Measure Income Generated by Remittances: The Case of the Kyrgyz Republic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 1.2 Hardship in Greece. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Figures 1.1 Annual GDP Growth in ECA and European Union, 2012–16 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 1.2 Investment Volume in the European Union Still Not Back to Pre-Crisis Levels, 2000–14 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1.3 Ongoing Contraction in the Eastern Part of ECA (percent) . . . . . . . . . . . . . . . . 7 1.4 Terms-of-Trade Losses Dwarf Slowdown in GDP, Azerbaijan, Kazakhstan, and the Russian Federation, 2013–15 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . 8 B1.1.1 Like Oil Prices, Gold Prices Have Declined Since 2013, 1960–14 (percent). . . . 10 B1.1.2 Kyrgyz Republic Income Growth Vastly Exceeded GDP Growth, but Is Now Being Reversed, 2006–15 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1.5 Greece and Ukraine in Crisis as GDP and Government Expenditures Decline, 2007–16 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 B1.2.1 Household Income and Expenditure in Greece Has Decreased More than GDP, 2004–14 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 B1.2.2 Higher Household Income Reduction for the Bottom of the Income Distribution in Greece, 2009–12 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 B1.2.3 Household Income Reduction for the Bottom of the Distribution in Greece, 2009–12 (US$). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 1.6 Commodity Prices Decline and Global Trade Slows. . . . . . . . . . . . . . . . . . . . . . 15 1.7 Gross Capital Flows to Emerging ECA Countries Have Fallen. . . . . . . . . . . . . . 15 Contents ●  v 1.8 Stock Markets in ECA Are More Affected by Commodity Dependency than China’s Volatility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 1.9 Greater Global Uncertainty Has Been Concentrated in Commodity-Dependent Exporters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 2.1 Real Oil Price Stability in Oil-Exporting and Oil-Importing Countries, Relative to CPI, 1995–2013 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 2.2 Different Exchange Rate Policies in the Russia Federation, Kazakhstan, and Azerbaijan, 2000–15 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 2.3 Real Exchange Rate Adjustment in Georgia and Armenia, 2000–15 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 2.4 Real Exchange Rate Diversification in Norway and Canada, 2000–15 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 2.5 The Russian Federation: Inflation during Boom, Depreciation during Bust, 2000–15 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 2.6 Changes in Relative Prices Redirect Exports across Destinations, Selected Countries, 2014–15 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 2.7 Growth Incidence Curves for the Oil Shock in the Russian Federation, 2011 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 2.8 Sectoral Shifts Triggered by Oil Price Decline in the Russian Federation, 2011 (percent). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 2.9 Unequal Distribution of Employment and Assets, such as Human Capital, across the Russian Population, 2011 (percent) . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2.10 Equal Distribution of Job Losses in the Contracting Nontradable Sectors in the Russian Federation, Excepting the Top Decile, 2011 (percent). . . . . . . . . 38 2.11 The Importance of Remittances as a Source of Income across the Income Distribution in the Kyrgyz Republic, 2011 (percent) . . . . . . . . . . . . . . . . . . . . . . 40 2.12 Dependence of the Distributional Impact of the Remittance Shock on the Anonymity Assumption in the Kyrgyz Republic, 2011. . . . . . . . . . . . . . . . . . . . . 41 Tables 2.1 Oil Price Elasticities of the Real Exchange Rate . . . . . . . . . . . . . . . . . . . . . . . . . 27 2.2 Poverty Increases in the Russian Federation after Oil Prices Fall, 2011 . . . . . . . 35 2.3 Poverty Increases in the Kyrgyz Republic after the Fall in Remittances, 2011. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 2.4 Characteristics of Remittance and Nonremittance Households in the Kyrgyz Republic, 2011. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Acknowledgments The Europe and Central Asia (ECA) Economic Update is a joint product of ECA’s Office of the Chief Economist, the Macro and Fiscal Management Global Practice, and the Poverty Global Practice, with inputs from the Developments Prospects Group. Part I was prepared by a team in the Chief Economist Office, led by Hans Timmer, and including Maurizio Bussolo, Dobrina Gogova, David Michael Gould, Patrizia Luongo, Tu Chi Nguyen, Georgi Panterov and Ekaterina Usha- kova. Chapter 1 benefitted from forecasts prepared by economists in the Macro and Fiscal Management Global Practice, which are presented in Part II, and fore- casts prepared by Ekaterine T. Vashakmadze, Marc Stocker and Seyed Reza Yousefi in the Development Prospects Group.  Valuable comments for Part I were provided by Joao Pedro Wagner De Aze- vedo, Andrew Burns, Maria Eugenia Davalos, Doerte Doemeland, Gohar Gyulu- myan, Aurora Ferrari, Birgit Hansl, Andras Horvai, Ivailo Izvorski, Naoko C. Kojo, Juan Pradelli, Carolina Sanchez, Ilyas Sarsenov and Gallina Andronova Vincelette. Part II with the country pages was prepared by teams in the Macro and Fiscal Management Global Practice (led by Andrew Burns, Ivailo Izvorski, and Miria Pigato) and in the Poverty Global Practice (led by Carolina Sanchez). These teams included the following staff: Enrique Aldaz-Carroll, Joao Pedro Wagner De Aze- vedo, Marina Bakanova, Ulrich Bartsch, Thi Thanh Thanh Bui, Cesar Cancho, Marie-Anne Chambonnier, Young il Choi, Alexandru Cojocaru, Maria Gabriela Inchauste Comboni, Barbara Cunha, Maria Eugenia Davalos, Agim Demukaj, Doerte Doemeland, Mariam Dolidze, Bakyt Dubashov, Olga Emelyanova, Ryan Espiritu, Gohar Gyulumyan, Birgit Hansl, Sandra Hlivnjak, Stella Ilieva, Saida Ismailakhunova, Kamer Karakurum-Ozdemir, Leszek Pawel Kasek, Naoko C. Kojo, Ewa Joanna Korczyc, Tigran Kostanyan, Christos Kostopoulos, Aurelien Kruse, Caterina Ruggeri Laderchi, Dorsati Madani, Sanja Madzarevic-Sujster, Mikhail Matytsin, Moritz Meyer, Jose Montes, Zakia Nekaien-Nowrouz, Minh Cong Nguyen, Trang Van Nguyen, Ruslan Piontkivsky, Catalin Pauna, Mona Prasad, Alisher Rajabov, Nadir Ramazanov, , Ilyas Sarsenov, Sarosh Sattar, Wil- liam Hutchins Seitz, Lazar Sestovic, Rashmi Shankar, Hilda Shijaku, Bojan Shim- bov, Kenneth Simler, Nistha Sinha, Emily Sinnott, Emilia Skrok, Ravshan So- birzoda, David Andrew Stephan, Congyan Tan, Ashley Taylor, Theo David Thomas, Eskender Trushin, Sergey Ulatov, Judy Yang. vii viii  ●   World Bank ECA Economic Update October 2015 Ekaterina Ushakova oversaw the layout and production of the report. Mi- chael Alwan edited and typeset the report. Cover illustration is based on artwork of Serge Maksimov. Paul Anthony Clare, Artem Kolesnikov and Shynar Jetpiss- ova provided communications and outreach support, including the dedicated webpage (http://www.worldbank.org/en/region/eca/publication/europe-and- central-asia-economic-update-october-2015). Abbreviations AKP Justice and Development Party, Turkey BH Bosnia and Herzegovina BHAS BH Agency for Statistics BOP Balance of payments BYR Belarusian ruble CAD Current account deficit CBR Central Bank of Russia CDS Credit default swap CGE Computable general equilibrium CHF Swiss franc CIS Commonwealth of Independent States CPI Consumer price index CROSTAT Croatian Bureau of Statistics EBRD European Bank for Reconstruction and Development ECA Europe and Central Asia ECAPOV Eastern Europe and Central Asia household survey data archive ECATSD ECA Team for Statistical Development ECB European Central Bank ECE Early childhood education EDP Excessive Deficit Procedure EEU Eurasian Economic Union EFSD Eurasian Fund for Stabilization and Development ELSTAT Hellenic Statistical Authority EUR Euro FBH Federation of Bosnia and Herzegovina FDI Foreign direct investment FYR Former Yugoslav Republic (of Macedonia) GDP Gross domestic product GOU Government of Uzbekistan GIC Growth incidence curve HBS Household budget survey HRK Croatian kuna IMF International Monetary Fund KIHS Kyrgyz Integrated Household Survey LFS Labour Force Survey MENA Middle East and North Africa ix x  ●   World Bank ECA Economic Update October 2015 MSE Micro and small businesses NBH National Bank of Hungary NBKR National Bank of Kyrgyz Republic NBR National Bank of Romania NBRB National Bank of Belarus NBS National Bank of Serbia NPL Non-performing loans NSI National Statistics Institute PIT Personal income tax PPP Purchasing power parity RUR Russian ruble S&P Standard & Poor’s SILC Survey of Living Conditions SOE State-owned enterprises SORS Statistical Office of the Republic of Slovenia TANAP Trans-Anatolia Natural Gas Pipeline WB World Bank WDI World Development Indicators WTI West Texas Intermediate Introduction Against the backdrop of a weakening global economy and volatility in interna- tional financial markets, countries of the Europe and Central Asia region (ECA) are transitioning to a new normal. Oil-exporting countries in eastern part of ECA face the difficult adjustment to low commodity prices. That adjustment unavoidably comes with sharp real dep- recations, job losses in construction and domestic services, falling asset prices (especially real estate and equity prices), increased fragility in partly dollarized financial sectors, and declining household incomes. Very similar adjustments are taking place in surrounding countries with strong links to oil exporters through remittances and trade flows. Because of terms-of-trade losses and sharp declines in real remittances, most of the affected countries have seen their purchasing power drop more than 10 percent this year, much more than suggested by GDP numbers. The adjustment in eastern part of ECA also comes with new opportunities in tradable sectors. Diversification strategies can now be much more successful than during the oil-price boom. That implies job creation in sectors that produce trad- able, non-oil products, and exports to new destinations. To seize these opportuni- ties policy makers have to embrace the new normal by using flexible exchange rates, absorbing negative side effects, and facilitating investments in new sectors with competitive job opportunities. In western part of ECA, the fragile recovery continues, despite significant headwinds in the global economy. In the European Union and the Western Bal- kans the new normal poses the question how to achieve a recovery of invest- ments without the tailwinds of a global credit boom. Especially for Southern European countries, access to finance will not be as easy as before 2008. Risks in western part of ECA are more balanced than in the east. While risks in the east are predominantly on the downside, west ECA countries are less af- fected by ongoing volatility in global financial markets. There are idiosyncratic risks in the west associated with large migrations of refugees escaping the Syrian war and the implementation of Greece’s reform program, as well as other linger- ing geopolitical issues. On the other hand, there are promising opportunities, created by a weaker euro and lower oil prices, that could stimulate investment more than anticipated in the baseline forecast that is presented in this report. The challenge for policy makers and financial markets is how to create an environ- ment that is conducive to a stronger rebound in private investments. Faster and more effective insolvency procedures, strengthened financial sectors, and higher absorption of E.U. structural funds could contribute to such a rebound. xi xii  ●   World Bank ECA Economic Update October 2015 This Economic Update consists of two parts: (i) Economic Outlook, compris- ing two chapters, and (ii) Country Pages. In Part I, the first chapter describes the outlook for GDP growth, and then goes beyond GDP in a couple of important areas. It shows that terms-of-trade losses for oil exporters this year are much larger than changes in GDP. Furthermore, the discussion suggests a way to cal- culate real values of remittances. For remittances-receiving countries the changes in real remittances also outweigh changes in GDP. Finally, the chapter shows that at the height of the Greek crisis, households in Greece suffered larger losses in income than suggested by GDP numbers. The second chapter is more analytical. It establishes the link between oil prices and real exchange rates, both theoretically and empirically. It also presents model simulations that describe the consequences of oil prices on sectoral pat- terns and income distribution. Understanding these pervasive impacts is crucial for the design of policy responses. Part II of this Economic Update contains 26 two-page Macro Poverty Outlook reports for ECA countries. PART I Economic Outlook 2 1 Fragile Recovery in the West, Difficult Adjustments in the East Summary • Against the backdrop of an uncertain global environment and a slowing glob- al economy, the European Union continues its fragile recovery, with expected 1.9 percent GDP growth this year. The recovery is broad-based. In Northern, Western, and Eastern Europe growth this year is expected to exceed growth in 2014 by half a percentage point. The acceleration in Southern Europe is on track to be a full percentage point. • This recovery is supported by the European Central Bank’s accodative mon- etary stance, and the subsequent 12 percent depreciation of the euro versus the U.S. dollar. This improved Europe’s near-term competitiveness compared to U.S. and Asian producers. A sustained recovery will require a pickup in in- vestments, which are still 10 percent below their peak level in 2007. • In the Eastern Europe and Central Asia region, or eastern ECA, the 1.5 percent GDP growth in 2014 is likely to turn into a 1 percent contraction this year. Moreover, income losses are far larger than 1 percent this year. Oil exporters have experienced declines in income this year, including terms-of-trade loss- es, of more than 10 percent associated with flagging oil prices. In surrounding countries income losses are also much larger than suggested by the GDP num- bers, because of the declining real values of remittances. • The sharp decline in income has pervasive impacts. It requires vast real depre- ciations, fiscal adjustments, shifts in production from nontradables to trad- 3 4  ●   World Bank ECA Economic Update October 2015 ables, and shifts in the direction of exports away from oil exporters towards Asian economies. At the same time, social safety nets and the resilience of banks are being tested. • Separately, the deep recession in Ukraine continues and in Greece GDP is once again shrinking as the country struggles to undergo needed economic reforms and capital controls continue to constrain economic activity. Also in those two countries GDP numbers tell only part of the story, as fiscal adjustments have put an additional burden on vulnerable households. Introduction Global headlines are dominated by the recent volatility in financial markets and disappointing growth in large, emerging economies. This negative news casts a shadow over the prospects in Europe and Central Asia (ECA). Reduced capital flows and weak global import demand add to ongoing challenges. Still, global weakness, while contributing to uncertainty, is not the main determinant of growth performance in the region. The main drivers are the continued domestic recovery, however fragile, in western ECA, and the difficult adjustment in east- ern ECA to the “new normal” of lower oil prices. The European Union and the Western Balkans are on track to achieve higher growth this year than last year, supported by accomodative monetary policy. Under current expectations higher growth will be sustained in 2016. The volatile global environment constitutes a downside risk, but there are also promising op- portunities. Current investment levels are still far below their peak in 2007, re- flecting the long reverberation of the banking crisis. Once the recovery progresses and the credit conditions normalize, the rebound in investment and overall growth may be stronger than is currently assumed in the baseline forecast. Policy measures to facilitate investments by start-up companies that can compete in global markets would be especially opportune at this juncture. At the same time, eastern ECA has been hard hit by declining commodity prices, with particularly large drops in oil prices. Income losses in oil-exporting countries are more than 10 percent this year because of the decline in oil reve- nues. Several surrounding countries are suffering equally large income losses because of the sharply reduced purchasing power of remittances. These income losses are not a mere macro phenomenon, but translate into sharply declining household incomes, with elevated poverty rates as a result. Under these circum- stances it is very difficult to prevent a drop in activity and an increase in unem- ployment. And indeed, many countries in ECA have fallen into recession. For policy makers, firms, and households it is crucial to recognize the dramatic re- alignment of relative prices, and to realize that this “new normal” not only brings challenges, but also creates opportunities to diversify. It is crucial that economies seize these opportunities as early as possible. The World Bank’s newly broadened coverage of the ECA region now includes the advanced countries in Western, Southern, and Northern Europe as well as its traditional coverage of Eastern Europe and Central Asia. Average GDP growth Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  5 for our expanded regional coverage is expected to be 1.5 percent this year, which is close to last year’s 1.4 percent growth rate. For 2016, growth is forecast to ac- celerate to 1.9 percent growth as the recovery in the European Union is expected to be sustained and the recession in ECA is likely to bottom out. Acceleration in the West For the western part of ECA—including Western, Northern, Central, and South- ern Europe as well as the Western Balkans—growth is expected to accelerate from 1.4 percent in 2014 to 1.9 percent in 2015. This is a continuous, albeit feeble, re- bound from a contraction of 0.4 percent in 2012 and the barely positive 0.1 percent growth in 2013. The pace of growth next year is expected to be 2 percent in west- ern ECA, matching this year’s growth (figure 1.1). Northern Europe is projected to experience a perceptible increase in growth in 2016 (from 1.9 to 2.3 percent), while Central Europe is likely to maintain its robust growth of around 3.3 percent. Southern Europe will likely see a modest accelera- tion from 1.3 percent growth in 2015 to 1.5 percent growth in 2016, but this is by far not enough to shed the legacy of the crisis. The Western Balkans will likely see growth accelerate to 2.3 percent in 2016, from 1.7 percent in 2015. However, unem- ployment will remain excessive, with nearly half of the youth labor force unem- ployed in recent years, compared to 20 percent in the rest of the European Union. FIGURE 1.1 Annual GDP Growth in ECA and European Union, 2012–16 (percent) 8 2012 2013 2014 2015e 2016p 6.6 6 5.6 5.2 5.0 4.2 3.2 4 3.3 3.2 3.5 3.4 3.4 3.2 3.5 Annual GPD growth (%) 2.8 2.7 2.8 2.9 1.5 2.02.3 2.2 2.3 2.1 1.8 1.9 1.8 2.0 2 1.5 1.5 1.4 1.7 0.41.4 1.4 1.3 0.5 1.3 0.5 0.4 0.4 0.6 0.6 0.6 0.3 0.4 0.2 0.0 0 -0.1 -0.3 -0.6 –2 -1.7 -2.9 –4 -3.8 -4.0 –6 –8 -9.1 –10 ECA Western EU Nothern EU Central EU Southern EU Western South Central Asia Other Russian Turkey Balkans Caucasus Eastern Europe Federation Year Source: World Bank data. 6  ●   World Bank ECA Economic Update October 2015 Despite this ongoing recovery in the European Union, growth falls short of what is needed to undo the damage of the crisis years and to put the region on a path of self-sustaining and balanced growth. Both external and domestic factors are responsible for this subpar performance. Externally, the slowdown in emerg- ing economies and in global trade and the weak capital flows constitute serious headwinds. Domestically, the investment climate is not favorable as govern- ments, financial sectors, firms, and households are still recovering from the after- math of the financial crisis, particularly in Central and Southern Europe. The consequence is continued fiscal consolidation, a deleveraged and risk-averse banking sector with high non-performing loans, and private spending that is constraint by debt overhang. Under these circumstances, it might not be surpris- ing that private investments are the missing link in the recovery. The volume of investments is still 10 percent below its 2007 level (figure 1.2). Higher growth will require policies that facilitate access to financing of new innovative companies and internationally competitive firms. The banking union should help improve the stability of the financial sector. However, the relatively small size of capital markets as an alternative source of financing to bank lending remains a limiting factor in the speed of recovery. Moves toward a capital markets union, although still at a very early stage, would help deepen private sources of capital. A unified capital market would consoli- date the investment climate across the region, support investors in assessing country risks, and deepen alternative sources of private investment. Contraction in the East The eastern part of ECA has experienced outright contraction over the last 12 months. Output is expected to decline 0.9 percent in 2015 and then recover to a modest 1.5 percent growth in 2016, as countries continue to adjust to lower oil prices. The sharpest declines have been in the Russian Federation, which is pro- jected to contract 3.8 percent in 2015 and 0.6 percent in 2016, due to ongoing FIGURE 1.2 Investment Volume in the 120 European Union Still Not Investment level (%) (2007 = 100) Back to Pre-Crisis Levels, 110 2000–14 (percent) 100 GDP 90 Gross fixed investment Government consumption 80 Exports, GNFS 70 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Year Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  7 FIGURE 1.3 Ongoing Contraction in the Eastern Part of ECA (percent) Industrial Production 2015H1 6m/6m annual growth 2 2014H2 Observations above 45 degrees line indicate accelerating growth 8.0 Central Europe Turkey Southern Europe EU and Western 3.0 Balkans Western Europe ECA Northern Europe South Caucasus –12.0 –7.0 –2.0 3.0 8.0 Central Asia 2014H2 Other Eastern Europe –2.0 2014H1 Eastern Europe and Central Asia Russia –7.0 –12.0 weakness in oil markets. Unlike the western part of ECA, which has seen ongo- ing acceleration of industrial production, most of the eastern ECA is seeing fur- ther contractions (figure 1.3). The South Caucasus, other Eastern European countries (Belarus, Moldova, and Ukraine), and Central Asia have been, directly and indirectly, hard hit by the fall in oil prices. The sharp real depreciations in oil-exporting countries had a large negative impact in surrounding countries through lower trade and remit- tances flows. Growth rates in 2015 are expected to be about half those seen in 2014 in the South Caucasus and Central Asia, while other Eastern European countries are estimated to have fallen further into recession. In Turkey, growth is projected to increase modestly from 2.9 percent in 2014 to 3.2 percent in 2015. As the re- gion’s markets adjust to lower prices, and advanced-country economies, particu- larly in the European Union and the United States, continue to expand, Eastern Europe, Central Asia, and Turkey are all expected to see higher, albeit modest, growth in 2016, while Russia is projected to continue to contract, but at a more modest pace. For countries directly and indirectly adversely affected by lower oil prices, GDP tells only a small part of the story when it comes to the sharp decline in spending power available to their citizens. The real domestic income of a country also includes terms-of-trade gains or losses, which result from changes in export 8  ●   World Bank ECA Economic Update October 2015 FIGURE 1.4 Terms-of-Trade Losses Azerbaijan Kazakhstan Russian Federation 10 Dwarf Slowdown in GDP, Azerbaijan, Kazakhstan, 5 and the Russian Federation, 2013–15 (percent) 0 2013 2014 2015 2013 2014 2015 2013 2014 2015 –5 Real GDP growth Terms-of-trade effect –10 –15 –20 BOX 1.1 How to Measure Income Generated by Remittances: The Case of the Kyrgyz Republic Workers’ remittances are a sizable source of income evant for the receiving countries? Let’s first look at for several countries in Europe and Central Asia two measures that are often used, but have signifi- (ECA). In Albania, Armenia, Georgia, the Kyrgyz cant problems. Republic, Tajikistan, and Uzbekistan, remittances • The nominal dollar amount is clearly not an exceeded 10 percent of GDP in at least one of the optimal measure. For example, an apprecia- last five years. It total, remittance inflows into ECA tion of the U.S. dollar compared to all other were an estimated US$165 billion last year. Obvi- currencies would automatically reduce the ously, households in the receiving countries benefit dollar amount of remittances from the Rus- directly from the money sent from abroad by family sian Federation to the Kyrgyz Republic, while and friends, but the large aggregate transfers also the amount in Russian rubles or Kyrgyzstani have significant macroeconomic impacts. som remains unchanged. Such a decline in So, remittances are substantial. But how exactly the dollar amount would also not affect the should we measure their size in a way that is rel- purchasing power of those who receive the (Continued) and import prices. The fall in the oil prices and the subsequent devaluation of the ruble caused large changes in import and export prices, and consequently large terms-of-trade losses. This has had a much stronger adverse impact on buying power than what is reflected simply by GDP (figure 1.4).  The real value of remittances received from abroad is also an important part of the purchasing power in a country that is not a consequence of real GDP1. The real value of remittances has sharply declined in the region because of real depre- ciations in countries where the remittances originate (box 1.1). 1. The real value of remittances refers here to the purchasing power of remittances in terms of imported goods and services, that is, nominal remittances deflated by the import price. Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  9 BOX 1.1 (continued) remittances, unless the remittances are used where is percentage growth of variable x; y is to buy U.S. products. real income; R, GDP, and X are nominal values of • The size of remittances relative to nominal respectively remittances, GDP, and exports; TOT is GDP in the receiving country seems a better terms-of-trade gains as percent of GDP; and pm, measure. This ratio is independent of curren- pg, and px are deflators of respectively imports, cies and makes remittances comparable to GDP, and exports. self-generated income. However, this mea- Combining equation B1.1 with equation B1.2 sure also has a disadvantage. When remit- shows that growth of real income consists of three tances surge, the nominal value of GDP tends components: growths of real remittances, real GDP to increase as well, as the increased transfers growth, and terms-of-trade gains. from abroad push up domestic prices. This is (B1.2) similar to the Dutch disease effect of high oil prices for an oil exporter (see Chapter 2 of this report). As a result, ex post remittances might be little changed relative to GDP, while the purchasing power created by the surge in remittances actually does increase. A better measure is remittances deflated by the This definition of overall income growth puts both import price. This expresses remittances in terms remittancesand GDP in perspective. When remit- of purchasing power of imports. This measure of tances are relatively large, the impact of changes “real remittances” is also independent of curren- in GDP on overall income or overall purchasing cies and can be added to real GDP. If one adds also power becomes relatively small. terms-of-trade gains, which takes into account the Instead of looking at GDP growth itself, it seems import capacity generated by export revenues, more relevant to look at the contribution of GDP to then we can define the growth of total real incomea overall income growth. as the weighted sum of the growth of real remit- In the Kyrgyz Republic, all three sources of tances and the growth of real income derived from income growth are substantial. In relative terms GDP. The latter is the sum of real GDP growth and only Tajikistan receives more remittances than the terms-of trade gains. This definition of the growth Kyrgyz Republic. Terms-of-trade gains and losses of total real income is expressed in equation B1.1: are also sizeable as the Kyrgyz Republic exports (B1.1) gold, which is subject to large price swings (see figure B1.1). From 2006 until 2012, total income grew on average 10 percent per year. GDP growth con- tributed only one third of that overall growth, remittances contributed slightly more than one third, and terms-of-trade gains were responsible for slightly less than one third of overall income growth. Because of terms-of-trade gains, driven by rising gold prices, income kept expanding in 2009, a. This income concept differs from gross domestic income and gross national income, which also include terms-of-trade gains, despite a decline in remittances. At the height of but don’t include all the remittance transfers. the global crisis gold prices kept rising as gold (Continued) 10  ●   World Bank ECA Economic Update October 2015 BOX 1.1 (continued) was one of the few safe havens for global inves- terms-of-trade gains turned into terms-of-trade tors. In those six years of high growth the capac- losses. In real terms, remittances began to decline ity to import surged spectacularly. Import vol- in 2014 and are estimated to have dropped dra- umes increased 77 percent, while export volumes matically in 2015. As a result, overall income growth increased 22 percent. was barely positive in 2014 and will be strongly After 2012 income growth declined dramati- negative in 2015, even with continued expansion cally. In 2013 gold prices started to decline and of GDP. FIGURE B1.1.1 Like Oil Prices, Gold Prices Have Declined Since 2013, 1960–14 (percent) 180 Oil/gold price, US$ (2010 = 100) Real crude oil price Real gold price, deflated 160 (average Brent, WTI, Dubai) by global manufacturing 140 deflated by global price (2010 = 100) 120 manufacturing price (2010 = 100) 100 80 60 40 20 0 6 01 6 01 6 01 6 01 7 01 7 01 7 01 7 01 7 01 80 01 8 01 8 01 8 01 8 01 9 01 9 01 9 01 9 01 9 01 0 01 0 01 0 01 0 01 0 01 1 01 1 01 14 01 01 19 M 19 2M 19 4M 19 6M 19 8M 19 0M 19 2M 19 4M 19 6M 19 8M 19 M 19 2M 19 4M 19 6M 19 8M 19 0M 19 2M 19 4M 19 6M 20 8M 20 0M 20 2M 20 4M 20 6M 20 8M 20 0M 20 2M M 60 19 Year FIGURE B1.1.2 Kyrgyz Republic Income Growth Vastly Exceeded GDP Growth, but Is Now Being Reversed, 2006–15 (percent) Rate of income growth (%) (2010 = 100) 20 15 10 5 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 –5 –10 Year Contribution of GDP Contribution of terms of trade gains Contribution of remittances GDP growth Income growth Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  11 Given the weaker buying power of many households in eastern part of ECA, poverty rates are expected to rise in several countries. This is a reversal of the downward trend toward lower poverty rates across the region. Poor households in oil-exporting countries and remittances-receiving countries are hit by higher im- port prices due to devaluations, the disappearance of jobs in construction and other nontradable sectors, and because of fiscal pressures. This highlights the need for a quick adjustment to the new economic reality. Only if countries seize new op- portunities in tradable sectors can the deterioration of poverty rates be stopped.  Exchange rate adjustments, along with prudent monetary policy to keep domes- tic inflation under control, will help countries regain competitiveness in global mar- kets in the eastern part of ECA. However, while structural reforms continue, the pace of longer-term reforms has slowed and large gaps remain for the eastern part of ECA, such as in competition policy, small-scale privatization, trade and foreign exchange regimes, and price liberalization. Reinvigorating reforms is key to build- ing economic resistance and setting the region back on the path to robust growth. ECA Countries in Crisis Within the last year, Ukraine and Greece both went through (and are still under- going) dramatic economic crises. While broader financial and economic conta- gion to rest of the ECA region has been restrained, the domestic consequences have been unprecedentedly harsh. The genesis of these crises are very different, but there have been several commonalities: unsustainable debt, drying-up of liquidity, and required large structural reforms and cutbacks in public expenditure. For Greece, the 2008 crisis exposed large fiscal imbalances, with subsequent attempts at debt restructuring and fiscal reforms being only partially successful. The unwinding of unsustainable conditions from the boom period caused a GDP contraction of more than 25 percent. The impact on households was much harsher, as the reduction of fiscal deficits came with higher taxes and lower trans- fers (box 1.2). Moreover, there is no quick resolution in sight becuase capital con- trols now constrain economic activity. Growth is forecasted to contract 2.5 per- cent in 2015 and a further 4 percent in 2016 (figure 1.5). The country is facing the FIGURE 1.5 Greece and Ukraine in Crisis 20 45 Growth in government expenditures (%) as GDP and Government 15 35 Expenditures Decline, 25 10 2007–16 (percent) 15 GDP growth (%) 5 Ukraine, GDP growth, % 5 0 Ukraine, Growth in Government 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 –5 Expenditures, % –5 Greece, GDP growth, % –15 –10 –25 Greece, Growth in Government Expenditures, % –15 –35 –20 Year –45 12  ●   World Bank ECA Economic Update October 2015 daunting task of enacting reforms that unleash new drivers of growth and build efficient social safety systems. In Ukraine, the conflict in the industrialized eastern regions brought adverse consequences for the country’s economy and Ukrainian people. Even prior to the conflict, fiscal accounts and balances were precarious and the daunting challenge is to achieve under current difficult circumstances debt restructuring and signifi- cant structural reforms, including the improvement of the business climate, de- centralization and reduction of the size of the state, SOE reform, and the creation of a national anti-corruption agency. The economy in Ukraine contracted 6.8 per- cent in 2014 and is forecasted to shrink 12 percent in 2015, with a modest recovery of 1 percent in 2016. BOX 1.2 Hardship in Greece Like many other countries, Greece has suffered There was a brief period of growth in 2014, but the from a big economic contraction since the financial long uncertainty of the bailout deal and the subse- crisis. But, unlike others whose GDP reduction has quent capital controls have made the country slide been either brief (2–3 years in the case of Iceland back into recession. and Ireland) or of smaller scale (less than 2 percent The economic contraction has led to even larger annually in Croatia and Spain), the contraction in deterioration of household incomes. During the Greece lasted much longer—six years of negative period of 2010–12, GDP per capita declined by an growth from 2008 to 2013—and was bigger—an average of 7 percent every year, accumulating to annual decline of 4 percent in GDP per capita. a total loss of about 20 percent. During the same This has accumulated to a reduction of output of period, household disposable income per capita nearly 26 percent, equivalent to shifting the Greek fell 14 percent yearly, almost double the GDP con- economy a full decade back into the past: the level traction, and the total three-year loss was 38 per- of output in 2012 was equivalent to that of 2000. cent (figure B1.2.1). As a result, absolute poverty (at FIGURE B1.2.1 Household Income and Expenditure in Greece Has Decreased More than GDP, 2004–14 (percent) Cumulative change (%) (2004 = 00) 120 100 80 60 GDP per capita 40 Income per capita 20 Household expenditure 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Year Source: World Bank’s World Develoment Indicators (WDI) for GDP; EU Statistics on Income and Living Conditions User Database (EU-SILC UDB) surveys 2005–13 for income; and the Greek statistics authori- ty ELSTAT (Press Release dated September 7, 2015) for expenditure. (Continued) Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  13 BOX 1.2 (continued) US$5 per day) increased by 6 percentage points, sources of income explain this difference in income from 2 percent in 2009 to 8 percent in 2012. Dis- losses across the distribution. First, labor income of saving allowed expenditure to fall less than income the bottom 40, which accounted for 70 percent of (–27 percent). total income, fell by around 47 percent, compared The income losses of the bottom quintile of the with a 39 percent reduction among the top 60 per- welfare distribution were more than 45 percent, cent of households. The rise in unemployment has significantly larger than the average decline of 38 affected the bottom 40 to a much larger extent percent (figure B1.2.2). The income of the bottom than the top 60 as the former group includes more 40 percent of households declined 41 percent. Two young people and the less skilled. FIGURE B1.2.2 Higher Household Income Reduction for the Bottom of the Income Distribution in Greece, 2009–12 (percent) 0 10 Cumulative change (%) 20 30 –33.4 –31.8 –32.1 40 –36.6 –38.0 –40.4 –40.0 –42.2 50 –45.6 –51.5 60 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 Income Labor Income Source: WDI for GDP, EU-SILC UDB surveys 2009–13. Second, middle-income households depend with elderly members was low to begin with (less more on pension income, and this has declined less than 0.3 percent) and hardly increased in the crisis, during the crisis, hence playing an important role in whereas an addition of 5.7 percent of households protecting many families from falling into poverty. without elderly members fell into poverty between Government expenditure on contributory pen- 2009 and 2012. Social transfers are small, account- sions actually increased since 2009, while spending ing for less than 5 percent of income of the bottom on social pensions and other benefits have gone 40; they covered few low-income households and down, including a big reduction in family/children played a limited role in protecting them from fall- benefits. As a result, pensioners’ incomes dropped ing into poverty.a less than the rest of the population (figure B1.2.3, a. A means-tested family benefit was introduced in late 2013 panel a). Household members also benefited from (which is not captured in data available for this Update), but it this resilience of pension income (figure B1.2.3, is difficult to estimate how much it will help mitigate the rise in panel b). The poverty rate among households poverty in households with children. (Continued) 14  ●   World Bank ECA Economic Update October 2015 BOX 1.2 (continued) FIGURE B1.2.3 Household Income Reduction for the Bottom of the Distribution in Greece, 2009–12 (US$) a. Income of pensioners fell less than other groups b. Households with elderly also suffer less Annualized income growth (%) Annualized income growth (%) 14,000 0 14,000 0 –2 –2 Income per capita 12,000 12,000 (US$ 2005 PPP) Income per capita –4 –4 (US$ 2005 PPP) 10,000 10,000 –6 –6 8,000 8,000 –8 –8 –10 6,000 –10 6,000 –12 –12 4,000 –14 4,000 –14 –16 2,000 –16 2,000 –18 0 –18 0 –20 n rly al de n er t re ld ou Em ed e ed ed n Re t em ired al el dre t de en tiv re To ild rly ly t &e th oy oy oy To ild ud ac el & hil t ch n wi pl pl pl in Ch th St c em th re H th wi er ild H wi wi lf- Un th H H Se O H H H H ch Labor force status Family type Income 2009 (left axis) Income growth 2009–12 (right axis) Source: WDI for GDP, EU-SILC UDB surveys 2009–13. Sources: This box draws on the brief “Poverty Impacts of the Greece Crisis and Potential Policy Responses,” by Gabriela Inchauste, Ramya Sundaram, Moritz Meyer, Natalia Millan, and Tu Chi Nguyen; and Hernan Winkler’s note on recent labor market developments in Greece. The External Environment has Raised Uncertainty The economic developments in ECA are unfolding against the backdrop of a deteriorating global environment. Slowing world trade and reduced capital flows have become strong headwinds, while low commodity prices pose serious challenges for the eastern part of ECA (figures 1.6 and 1.7 ). These headwinds are likely not short-lived, but rather herald a “new normal.” The causes of the weak environment are more of a structural than a cyclical na- ture. Trade is on a slower trend as potential growth in emerging economies has become more tempered and rapid expansion after past trade liberalization has faded. Commodity prices are suppressed as mining and exploitation capacity has cumulated over the last decade. Capital flows are less abundant as monetary policy in the United States normalizes. Gross capital flows to emerging markets (equity, bonds, and bank lending) began to soften in May 2015 as expectations of higher returns in developing coun- tries weakened relative to stronger prospects in the United States. For ECA, the capital flows had already declined in 2014, mostly attributable to lower bank lending to Russia, as capital inflows weakened for all commodity exporters.2 In 2. In the short run, however, some of these commodity-exporting countries may experience an uptick in flows as demand increases. For example, capital flows into Kazakhstan have increased, as the country has sold several large bond issues to compensate for deteriorating oil revenues. Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  15 FIGURE 1.6 Commodity Prices Decline and Global Trade Slows a. Energy and commodity prices, 2014–15 (percent) b. World merchandise trade volumes, 1991–2015 (log index) 140 140 135 120 Log index (1991 = 100) 130 Prices (%) (2004 = 100) 100 125 120 80 115 110 60 105 40 100 95 20 90 /2 4 /2 4 1/ 014 01 01 01 01 01 01 01 01 01 01 01 01 01 2/ 4 3/ 014 4/ 014 5/ 014 6/ 014 7/ 014 8/ 014 9/ 014 10 014 11 201 12 201 2/ 15 3/ 015 15 1 m m m m m m m m m m m m m 20 /2 20 20 2 2 2 2 2 2 2 2 / / 2 91 93 95 97 99 01 03 05 07 09 11 13 15 /2 2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/ 2/ 19 19 19 19 19 20 20 20 20 20 20 20 20 1/ 2/ Year Year Crude oil (Brent) Copper Steel Gold FIGURE 1.7 Gross Capital Flows to Emerging ECA Countries Have Fallen a. Average monthly gross capital flows by region b. Monthly gross capital flows by region, Jan-July 2015 30,000 45,000 40,000 1/13/2015 25,000 2/13/2015 35,000 20,000 3/13/2015 30,000 US$ million 4/13/2015 US$ million 15,000 25,000 5/13/2015 20,000 10,000 6/13/2015 15,000 7/13/2015 5,000 10,000 0 5,000 2010 2011 2012 2013 2014 2015 Year 0 EAP ECA LAC SA EAP ECA LAC MNA SA SSA Region c. ECA average monthly capital flows d. ECA gross capital flows by subregion 20,000 35,000 18,000 30,000 16,000 25,000 14,000 US$ million 20,000 US$ million 12,000 10,000 15,000 8,000 10,000 6,000 4,000 5,000 2,000 0 0 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Year Year South Caususes Central Asia Central Europe and The Baltics Bonds Equity Loans Ukraine Russia Turkey Note: 2015 represents monthly average through July 2015. 16  ●   World Bank ECA Economic Update October 2015 FIGURE 1.8 a. Recent volatility in stock markets occured mainly in China Stock Markets in ECA Are More Affected by 300 Stock market indices in local currencies Commodity Dependency 250 than China’s Volatility (January 2010 = 100) 200 China S&P Germany 150 Brazil India Japan South Africa 100 50 0 14 14 4 4 4 15 15 15 15 15 15 15 15 01 01 01 20 20 20 20 20 20 20 20 20 20 /2 /2 /2 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ /1 /1 /1 8/ 9/ 1/ 2/ 3/ 4/ 5/ 6/ 7/ 8/ 10 11 12 Year b. China’s stock market behaves differently 250 local currencies (%) (January 2010 = 100) China Change in stock market indices in Germany 200 United States 150 100 50 0 01 01 01 01 01 01 01 01 01 01 M M M M M M M M M M 06 07 08 09 10 11 12 13 14 15 20 20 20 20 20 20 20 20 20 20 Year c. Stock markets in oil exporting countries have been under pressure Iceland China Ireland Malta Slovak Rep. Latvia Denmark Korea, Rep. Tunisia Hungary Ukraine Nigeria Egypt, Arab Rep. United Arab Emirates Saudi Arabia Kazakhstan Russian Federation Colombia Peru Greece –50 –30 –20 –40–10 0 10 20 30 40 50 Change in stock markets indices in local currencies (%) (September 2014 and September 2015; 10 largest declines and 10 largest increases) Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  17 2015 capital flows into ECA further declined, as the uncertainty in bond markets affected Central Europe and the Baltics. This deterioration of the global environment came with large losses in several stock markets, but these losses were not uniform. Apart from the dramatic burst of China’s short-lived stock market bubble, the losses were concentrated in commodity-exporting countries, as exemplified by the relatively strong fall in equity prices in Brazil and South-Africa (figure 1.8). In Europe and Central Asia, most markets have contin- ued to remain stable or post modest gains compared to year earlier levels, while Russia and neighboring countries have posted losses. Dependency on commodity markets and large borrowing requirements seems to have been much more impor- tant in recent months than general contagion of China’s stock market adjustment. These headwinds are incorporated in the baseline outlook, but risks surround- ing that outlook have also intensified. In the transition to the “new normal” un- certainty and risks have increased, as for example reflected in rising spreads in global bond markets (figure 1.9). A big source of uncertainty is how smooth the FIGURE 1.9 a. Emerging Market Bond Index (EMBI) strip spreads for large Greater Global Uncertainty emerging market economies Has Been Concentrated 600 in Commodity-Dependent 550 Exporters 500 450 EMBI spread (%) Brazil China India South Africa 400 350 300 250 200 150 100 4 5 4 4 5 5 5 4 5 5 5 4 5 15 -1 -1 -1 -1 r-1 -1 -1 -1 -1 -1 -1 -1 -1 n- ug ug ct ov ar ay ec ul un eb ep an Ap Ju -O -M -J M -N -D -A -A -J -J -F -S 7- 28 2- 5- 21 30 13 10 26 25 18 10 16 23 Year b. Bond spreads moved with oil prices for oil exporters, and were stable for oil importers (spreads in basis points; oil price in US$ per barrel) 600 0 EMBI spread, oil exporters Crude Oil, Brent per barrel (US$) (Azerbaijan, Kazakhstan, 550 Russian Federation) 20 500 EMBI spread, Central Europe 450 EMBI spreads (%) 40 Crude Oil, Brent 400 (right-hand axis, reverse scale) 350 60 300 80 250 200 100 150 100 120 4 4 4 5 5 5 5 5 15 5 5 5 4 4 -1 -1 -1 -1 -1 -1 -1 -1 r-1 -1 -1 -1 -1 n- ar ct ov ec an eb ay un ul ug ug ep Ap Ju -J -M -O M -D -N -J -J -A -A -S -F 7- 2- 28 5- 13 30 21 10 23 10 16 18 25 26 Year 18  ●   World Bank ECA Economic Update October 2015 adjustment can be in the Chinese economy to lower growth and lower invest- ment, after decades of rapid expansion and the current excessively high invest- ment rates because of effective stimulus in recent years. Another source of uncer- tainty is the timing of monetary tightening by the U.S. Federal Reserve. The Fed chose not to raise rates in its September 16th meeting, partly in response to dete- riorating global conditions. But the unwinding of the Fed’s easy monetary policy is unlikely to be postponed for long. Like the deterioration of the global environment, increased uncertainty has mainly affected commodity exporters, which experienced much sharper rises in spreads than average. Average credit spreads in the large, commodity-exporting, emerging-market economies (particularly Brazil and South Africa) have in- creased substantially since May 2015 by almost 100 basis points. Spreads for In- dia and China have also increased, but much less. As a result, the downside risks are especially large in countries with large external financing needs (Turkey) and that, directly or indirectly, depend on com- modity exports (Russia, Central Asia, and the South Caucasus). In this environ- ment policy makers have to be proactive in enacting measures that can mitigate negative consequences and help seize new opportunities. To build economic re- sistance and set the stage for robust growth in the eastern ECA, adjusting to the “new normal” of low oil prices with exchange rate flexibility and an agile busi- ness climate is critical. For the other parts of ECA (Northern, Western, Southern, and Central Europe, and the Western Balkans) risks are more balanced. These countries are less af- fected by ongoing volatility in global financial markets. On the under hand, there are also promising opportunities. If the fragile recovery continues, benefitting from a weaker euro and lower oil prices, then the rebound in investment may well become stronger than anticipated in the baseline. The challenge for policy makers and financial markets is how to stimulate and facilitate such a stronger rebound in private investments. Conclusions Overall growth is expected to increase in the ECA region during 2015 and acceler- ate in 2016. However, the region has still not fully recovered from the aftereffects of the global financial crisis. ECA is in the midst of strong crosswinds, with the western part seeing steady growth and the eastern part seeing further contrac- tion. Much of the eastern ECA is hard hit by declining commodity prices, particu- larly oil. Geopolitical risks and increased financial market volatility in emerging markets are dampening potential growth across all countries. To build economic resilience and set the stage for robust growth in eastern ECA, adjusting to the “new normal” of low oil prices with exchange rate flexibility and an agile busi- ness climate is critical. For western ECA, the recovery remains fragile. A sustained recovery is only possible with a rebound in investments, which are still below pre-crisis levels. Europe’s heavy reliance on the banking sector and the cumbersome resolution of Chapter 1: Fragile Recovery in the West, Difficult Adjustments in the East ●  19 the debt overhang have delayed this rebound. The global uptick in financial mar- ket volatility as well as lingering geopolitical risks have made the necessary re- covery of investments more uncertain. The relatively small size of capital markets as an alternative source of financing to bank lending also has limited the speed of recovery. Moves toward deepening capital markets and improving the climate for private investment will further solidify the economic expansion. 2 Oil Prices and Real Exchange Rates Summary Exchange rate depreciations of 30 percent or more in Eastern Europe and Central Asia over the last year are part of a transition toward a new equilibrium. Many structural changes occurred during the oil boom, including real appreciations, shifts toward the production of nontradable goods and services, and sharp rises in real estate prices. These have to be reversed now that the oil prices are at a structurally lower level. The required changes are not limited to oil-exporting countries. Neighboring countries that received large amounts of remittances from workers in the oil-ex- porting countries experienced similar structural changes during the oil boom. Changes in these countries will also have to be reversed. For oil-dependent countries, adjusting to lower oil prices is much more diffi- cult than adjusting to higher oil prices. The drop almost always happens much faster than the rise. Moreover, while during an oil boom the associated real ap- preciation can be accommodated by either nominal appreciations or higher infla- tion (or a combination of the two), the real depreciation after the oil price drop is typically only be achieved by nominal depreciation of local currencies, as large domestic deflation is difficult to achieve in practical terms. However, depreciation of currencies tests the stability of financial markets that are partly dollarized. Governments, firms, and households should recognize the unavoidable per- vasive changes. Postponement of adjustments will increase the costs and prevent the creation of new jobs in tradable sectors. Rapid adjustment will create new 21 22  ●   World Bank ECA Economic Update October 2015 opportunities as real depreciation implies increased competitiveness in interna- tional markets. Diversification strategies will have now much more success than during the oil boom. This allows a shift toward non-oil exports, and within ex- ports a redirection toward Asia and Western Europe, away from trade with oil- dependent countries. Declines in oil revenues and remittances affect poor households through sev- eral transmission channels: (i) prices of imported goods (including food for many countries) rise, which reduces real income and real consumption; (ii) fiscal pres- sures may leave less room for transfers; (iii) the number of jobs in nontradable sectors (especially construction) will shrink; and (iv) the purchasing power of remittances sharply declines. Under these circumstances, efficient and targeted social safety nets are essential. It is equally important that obstacles to growth of companies that can seize new opportunities in tradable sectors are reduced. For example, banks should be ready to provide credit to small exporting firms, rather than merely to oil-related and construction-related firms, which have dominated these economies during the oil boom. Introduction Societies in Eastern Europe and Central Asia face huge challenges as their econo- mies need to adjust to a new normal. For households and firms, the challenges are how to adjust to lower incomes and dramatically different relative prices, and how to seize new opportunities that are created by the improved competitive- ness. For governments, the challenges are how to facilitate the reversal of struc- tural changes that occurred during the oil boom, how to prevent financial insta- bility, and how to protect the most vulnerable. For firms, households, and governments alike, it is important to recognize that pervasive structural adjustments are unavoidable. This chapter aims to contrib- ute to the understanding and recognition of these structural changes. The chapter contains three parts. In the first part (following this introduction) the theoretical relationship between oil prices (and remittances) and real ex- change rate is discussed with the help of a simple economic model. The second part presents an econometric analysis of the empirical relation between oil prices and real exchange rates. The third part analyzes the impact in the Russian Fed- eration of the oil price drop on production patterns and on incomes of individual households. The third part reports the outcomes of model simulations with a general equilibrium model and a microeconomic simulation model. Dutch Disease in a Nutshell Real exchange rates of oil-exporting countries are strongly correlated with oil prices for a simple reason. If oil prices rise, income in an oil-exporting country increases. The government, firms, and households want to spend the additional income on domestically produced goods and imports. Supply of imports is elas- tic, implying that the increased demand for imports can easily be met by in- Chapter 2: Oil Prices and Real Exchange Rates ●  23 creased volumes of imports, without significant upward pressure on import prices. Supply of domestically produced goods and services, however, is inelas- tic. Therefore, increased demand creates upward pressure on prices—including, for example, prices for real estate and restaurant services. As a result, not only the energy price, but also all domestic prices and wages, rise relative to prices and wages abroad. In other words, the country experiences a real appreciation. Because of the real appreciation, companies producing internationally trad- able non-oil products find it increasingly difficult to compete in international markets. This loss in competitiveness because of rising oil revenues was coined “Dutch disease” by The Economist, describing the consequence of rising gas rev- enues in the Netherlands during the 1970s. The real appreciations were very visible in the region when oil prices rose. For example, during the oil price boom that started in 2000 domestic prices in Russia doubled relative to prices in the United States.1 The cost of living became very high in Moscow for foreigners, but not for Russian citizens, whose income went up with the domestic prices. The main impact for Russian citizens of the higher oil prices was that imports became cheaper. The mirror image of the relatively cheap imports is that Russian exports became relatively expensive. With rising oil prices, oil-exporting countries become less competitive in non-oil exports. This loss in competitiveness is often referred to as Dutch disease or the transfer problem. This mechanism is not limited to oil exporters, but is basically the same for countries that receive large transfers from abroad like remittances or aid flows. The recipients of higher oil prices (government and firms) are different from the recipients of remittances (households). However, the macroeconomic impact is very similar. Once the additional income is spent (either by governments, firms, or households) in the domestic economy, all prices and wages will go up and everybody will experience an increase in purchasing power as imports become relatively cheap. The expected correlation between the real exchange rate and oil prices can more formally be illustrated with a small model. A country produces a fixed amount of oil (e) that is exported. Furthermore, the country produces non-oil goods and services (q), which can be exported (x) or sold domestically (d). Its consumers demand the domestic goods and services (d) as well as imports (m). Assume relative spending on imported and domestic products can be described as follows in equation 2.1:2 (2.1) where is the price of domestically produced goods and services, relative to the import price (this domestic price relative to an international price can be seen as 1. This happened despite the fiscal rule to automatically save some of the oil revenues in a sovereign wealth fund if oil prices exceeded a threshold level. The sovereign wealth fund and the associated surpluses on the trade balance mitigated but did not prevent the real appreciation. 2. This indicates that preferences can be described by a Cobb-Douglas utility function and implies that the price elasticity of imports equals one, which is close to or just above what is frequently found in empirical literature. 24  ●   World Bank ECA Economic Update October 2015 the real exchange rate); and μ is the preference for imports and equals the share of imports in the total value of consumption. Total exports comprise energy exports (e), which are exogenous, and non-en- ergy exports (x). Demand for the latter is a function of the real exchange rate. If domestic prices increase relative to international prices, then the exports become expensive for foreign buyers and demand for these exports declines, as shown in equation 2.2: (2.2) where θ is a scale parameter and γ is the price elasticity of exports, often esti- mated to be around 2. The model can be closed by assuming that the trade balance is in equilibrium, as shown in equation 2.3: (2.3) where is the price of energy relative the import price, and e is the exogenous volume of energy exports. Equation 2.4 further contains the assumption that domestic production capac- ity (q) is fully used to produce domestically consumed products (d) and non-en- ergy exports (x): (2.4) Combining these four equations establishes the implicit relationship between the real exchange rate and energy prices shown in equation 2.5: (2.5) This relationship implies energy price elasticity of the real exchange rate, as shown in equation 2.6: (2.6) where β is the energy price elasticity of the real exchange rate; the share of energy in overall export revenues is ; and the ratio between non-energy exports and domestically consumed non-energy production is . If there are no energy exports (θ=0), then the elasticity is zero: the energy price has no impact on the real exchange rate. If all exports are energy exports (θ=1 and σ=0), then the elasticity is 1: a percentage change in the energy price requires an equal percentage change of the real exchange rate. Most energy exporters will be in between these two extremes. The larger the share of energy in total exports, the larger the elasticity. The larger the share of non-energy in domestic production, Chapter 2: Oil Prices and Real Exchange Rates ●  25 the smaller the elasticity. So, a more diversified, more open economy is expected to experience smaller changes in the real exchange rate when oil prices change. That is indeed confirmed by the empirical analysis presented in the next section, where the elasticity β from equation 2.5 is estimated in a log-linearized form in equation 2.7: (2.7) The correlation between domestic prices and oil prices has interesting side effect. From the perspective of households and firms in oil-exporting countries, relative oil prices are much less volatile than from the perspective of households and firms in oil-importing countries. Figure 2.1 provides a rather striking illustra- tion of that observation. In contrast to what happens in an oil-importing country, relative oil prices hardly changed in oil-exporting countries. The implication is that when oil prices are high there are fewer incentives to save energy in oil-ex- porting countries (even absent subsidies) than there are in oil-importing coun- tries. Another implication is that when oil prices fall in world markets, house- holds in oil-exporting countries hardly experience that the cost of energy has come down. Because of the real depreciation oil prices hardly change relative to domestic prices and wages. The change in real exchange rates has many other consequences. One is that in case of higher oil prices the production of non-oil tradables in an oil-exporting country is decimated. Non-oil exports decline and imports increase sharply. Do- mestic production is increasingly concentrated on nontradables. Another consequence is that purchasing power of wages will increase. This is because import prices will fall relative to domestic producer prices, while nomi- nal wages are linked to the producer prices. Because of the real appreciation, every- body becomes richer as imports become more affordable. In the first half of the previous decade this phenomenon accounted for an annual 10 percent increase of real income in Russia, on top of what was generated by productivity increases. FIGURE 2.1 Real Oil Price Stability 400 in Oil-Exporting and 350 Oil-Importing Countries, Oil prices relative to GDP (%) Relative to CPI, 300 1995–2013 (percent) 250 Japan 200 Russian Federation 150 100 50 0 01 01 01 01 01 01 01 01 01 01 01 M M M M M M M M M M M 95 97 99 01 03 05 07 09 11 13 15 19 19 19 20 20 20 20 20 20 20 20 Year 26  ●   World Bank ECA Economic Update October 2015 Once oil prices fall, and are expected to remain low for a considerable time, appreciation has to be reversed. As real incomes decline, imports become more expensive and will have to be reduced. Production capacity and jobs in the trad- able sectors will have to be built up again, and new export channels will have to be opened. Real depreciation is the main trigger behind these changes, as it re- stores competitiveness in the nontradable sector. The world is more complicated than described in the simple model that is discussed in this section. Domestic production is not completely inelastic. Pro- duction capacity can be boosted by attracting foreign capital and foreign work- ers. Linked to those cross-border flows, the value of imports does not necessarily equal the value of exports. Moreover the price elasticity of imports can deviate from one. Nevertheless, the basic thrust of the simple model is empirically rele- vant. The next section shows that in out-of-sample forecasts, estimated elastici- ties explain rather accurately some recent big changes in exchange rates. Such accurate forecasting means that these recent exchange-rate movements do not signal general volatility in financial markets. Rather, they reflect adjustments to- ward new equilibrium-relative prices, as explained by the simple model in this section. Empirical Evidence of (Reversed) Dutch Disease The previous section explained how the real exchange rates of oil-exporting countries are linked to oil prices. The analysis suggests a stronger positive cor- relation for countries with less-diversified exports and for countries in which oil is a larger part of overall production. This section provides empirical evidence of these results. In this empirical analysis we estimate the impact of oil prices on domestic prices, both relative to an international price. The consumer price index (CPI) is used as the domestic price, and the CPI in the United States is used as the international price. The use of CPIs has two ad- vantages. First, monthly data are available for these price indices. Second, the domestic CPI relative to a foreign CPI, both expressed in the same currency, is a common measure of the real exchange rate.3 The oil price is the unweighted aver- age of Brent, West Texas Intermediate (WTI), and Dubai oil prices. Equation 2.7 of the previous section is used to estimate the elasticity β: . Table 2.1 shows the estimation results. The elasticity for the oil exporters in Eu- rope and Central Asia is twice the size of the elasticity of Canada and Norway. That is consistent with the more-diversified character of the economy in the latter two countries. 3. The change in the real exchange rate equals the change in the nominal exchange rate, corrected for inflation differentials in local currencies. Chapter 2: Oil Prices and Real Exchange Rates ●  27 TABLE 2.1  Oil Price Elasticities of the Real Exchange Rate (t-values in parentheses) Russian Kyrgyz Norway Federation Kazakhstan Azerbaijan Armenia Georgia Republic Canada Elasticity (β) 0.25 0.64 0.47 0.56 0.52 0.51 0.45 0.29 (21.95) (34.23) (29.82) (21.02) (26.39 ) (34.83) ( 25.46) (39.13) R2 0.72 0.87 0.83 0.71 0.79 0.87 0.78 0.89 Number of 183 183 183 183 183 183 183 183 observations Particularly interesting is the very high elasticity for Armenia, Georgia, and the Kyrgyz Republic, which are not themselves oil-exporting countries. But be- cause of their close relations with oil-exporting countries, their economies react in a similar way to oil price changes. The main transmission channel is substan- tial worker remittances, which are 21 percent of GDP in Armenia, 12 percent in Georgia, and 31 percent in the Kyrgyz Republic. When oil prices raise real ex- change rates in oil-exporting countries, the value of remittances in terms of an international currency rises too, in turn pushing up wages and prices in the re- mittance-receiving countries. Another, but less important, transmission channel is exports from the surrounding countries to the oil exporters. Rising oil prices in oil-exporting countries lead to increased import demand from neighboring coun- tries, again raising prices and wages in those bordering countries. The result is a sharp real appreciation compared to the rest of the world when rising oil prices spread across the borders of the oil-exporting countries. In 2015 the value of re- mittances in oil-exporting countries is deflated with the fall in oil prices. Thus, neighboring economies also require sharp real depreciations compared to the rest of the world. Figure 2.2 shows how the estimated equations track the real exchange rates of three oil exporters: the Russia Federation, Kazakhstan, and Azerbaijan. The dot- ted lines indicate the model results, including out-of-sample forecasts after March 2015. The solid lines indicate the actual real exchange rates. The graphs show that the Russian real exchange rate closely follows the value expected on the basis of changes in the oil price. This is especially true for 2015, after the decision to float the nominal exchange rate of the ruble. The rebound in the spring of 2015, following the temporary rise in oil prices, might have overshot a bit. The amplitude of the both the actual and expected swings in the real ex- change rate are spectacular. The real exchange rate tripled during the long oil boom and halved during short periods of collapsing oil prices. These swings il- lustrate how powerful this mechanism is. The actual real exchange rate in Kazakhstan has been less flexible than the Russian rate. Still, the outcomes broadly follow the expected pattern on the basis of oil prices. Interestingly, after the recent float of the tenge, the real exchange rate immediately adjusted to what the estimated equations consider an equilibrium level. The depreciation of the tenge corrected an imbalance that was building up in the Kazakh economy. In Azerbaijan the real exchange rate is much more stable than in the other two oil-exporting countries. However, Azerbaijan also experienced a sharp real ap- 28  ●   World Bank ECA Economic Update October 2015 FIGURE 2.2 a. Ruble adjustment closely follows oil prices Different Exchange Rate Policies in the Russia 250 Federation, Kazakhstan, and Azerbaijan, 200 Adjustment rate (%) 2000–15 (percent) 150 Real exchange rate 100 compared to US$ Equilibrium real 50 exchange rate 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 20 Year b. Tenge adjustment moves toward equilibrium 250 200 Adjustment rate (%) 150 100 50 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 Year 20 c Azerbaijan adjustment is discrete and incomplete 250 200 Adjustment rate (%) 150 100 50 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 20 Year Chapter 2: Oil Prices and Real Exchange Rates ●  29 preciation during the oil price boom. This happened for a small part through appreciation of the nominal exchange rate, but for a much larger part through higher inflation than abroad. The devaluation of the manat in February 2015 moved the real exchange rate toward its expected value. This is in contrast to two other oil exporters, Russia and Kazakhstan, which are tracking the equilibrium value more closely. Figure 2.3 shows that swings in real exchange rates are not limited to the oil exporters. For example, Georgia and Armenia have experienced similar develop- ments. In the most recent period, Georgia adjusted substantially more than Ar- menia. The final illustration of the estimation is for Norway and Canada, two oil exporters that are more diversified than the oil producers in Europe and Central Asia. That is reflected in the much smaller amplitude of the swings in real ex- change rates in these two countries (figure 2.4). Nevertheless, those countries also have experienced noticeable real depreciations over the last year. FIGURE 2.3 a. Georgia has adjusted more Real Exchange Rate Adjustment in 250 Georgia and Armenia, 2000–15 (percent) 200 Adjustment rate (%) 150 Real exchange rate compared to US$ 100 Equilibrium real exchange rate 50 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 Year 20 b. Armenia has adjusted less 250 200 Adjustment rate (%) 150 100 50 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 20 Year 30  ●   World Bank ECA Economic Update October 2015 FIGURE 2.4 a. Norway Real Exchange Rate Diversification in 250 Norway and Canada, 2000–15 (percent) 200 Adjustment rate (%) 150 Real exchange rate compared to US$ 100 Equilibrium real exchange rate 50 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 20 Year b. Canada 250 200 Adjustment rate (%) 150 100 50 0 01 06 11 04 09 02 07 12 05 10 03 08 M M M M M M M M M M M M 00 01 02 04 05 07 08 09 11 12 14 15 20 20 20 20 20 20 20 20 20 20 20 Year 20 All these graphs of real exchange rates show that a real appreciation is much more gradual than a real depreciation. This reflects the fact that it took much longer for oil prices to rise than to fall. The slow rise phenomenon is also common in the case of asset bubbles. It takes much longer for capital to flow into an asset boom than to flow away once the bubble bursts. The rapid pace of developments is one of the many challenges for policy mak- ers in the current situation. Moreover, the adjustments associated with the cur- rent rapid real depreciation have to be implemented in an environment of large income losses. As was shown in chapter 1, income losses in oil-exporting coun- tries will exceed 10 percent this year. Another difference between the real appreciation during the oil boom and the current real depreciation is that the former could be achieved by either nominal appreciation or by additional inflation, whereas deflation is not really an option and nominal depreciation is the only viable way to achieve equilibrium. Defla- tion can probably only be achieved by a deep recession, which can be prevented Chapter 2: Oil Prices and Real Exchange Rates ●  31 or at least mitigated with nominal depreciations. A complication for policy mak- ers is, however, that many of the affected countries have partly dollarized finan- cial sectors. That means that authorities have to put measures in place to stabilize financial sectors at the same time as they allow the currency to depreciate. Depreciation of the nominal currency has also important advantages. It miti- gates fiscal pressure, because governments in oil-exporting countries receive oil revenues in dollars, while many of their expenditures are in local currency. In general, a nominal depreciation immediately spreads the burden of the oil reve- nue loss across the economy, just as real appreciation during booms spreads the benefits across the economy. Moreover, the nominal depreciation immediately creates the required improved competitiveness in non-oil tradable sectors. Pre- venting the needed depreciation is very costly. First of all, foreign exchange re- serves are lost to counteract downward pressure on the currency. Second, it puts more pressure on the fiscal situation than needed. Third, and most important, it prevents the shift toward the production of non-oil tradables. Figure 2.5 illustrates the different drivers behind real appreciations and depre- ciations for the Russian Federation. The red line shows the real exchange rate, or in other words the cumulative real appreciation. The yellow and green bars add up to this cumulative appreciation. The yellow bars indicate how much of the cumulative change in the real exchange rate was caused by inflation differentials and how much was caused by changes in the nominal exchange rate. Clearly, the role of the nominal exchange rate was minimal during the oil price boom. How- ever, during periods of sharp drops in oil prices (early 2009, late 2014) all of the adjustment came from depreciations of the nominal exchange rate. The recent sharp real depreciations in the region imply improved opportuni- ties for producers of non-oil tradable goods and services. The mirror image of a real depreciation is improved competitiveness compared to producers in coun- tries that did not experience the real depreciation. This leads to a shift toward non-oil exports and within the exports a shift away from Russia toward China and Turkey. Figure 2.6 shows the five largest export destinations for six countries that experience real depreciations. The numbers inside the pie charts indicate FIGURE 2.5 The Russian Federation: 80 Cumulative changes in logs of relative prices Inflation during Boom, Depreciation during Bust, 60 compared to U.S.prices (%) 2000–15 (percent) 40 Relative inflation 20 Exchange rate appreciation Real appreciation 0 2000M01 2001M01 2002M01 2003M01 2004M01 2005M01 2006M01 2007M01 2008M01 2009M01 2010M01 2011M01 2012M01 2013M01 2014M01 2015M01 –20 –40 Year –60 32  ●   World Bank ECA Economic Update October 2015 FIGURE 2.6 Changes in Relative Prices Redirect Exports across Destinations, Selected Countries, 2014–15 (percent) Russian Federation Kyrgyz Republic Kazakhstan China Ukraine Switzerland Kazakhstan United Arab Emirates Netherlands Belarus Other Russian Federation Turkey Other –46.09% 14% –45.3% 4.5% –20.3% –5.9% 20.3% –17.4% –8.1% NA –16.4% Kazakhstan Georgia China Russian Federation Turkey Azerbaijan Ukraine Turkey United Kingdom Uzbekistan Other Russian Federation United States Other 4.3% –0.55% –3.14% –2.75% 31.5% 14% 10.6% 17.96% –22.95% Azerbaijan Armenia Russian Federation Iraq Turkey Russian Federation Bulgaria Belgium Afghanistan Kazakhstan Other United States Germany Other 10.44% 21.5% –30.85% 9% –7.34% 8.3% 8.5% –12.6% Chapter 2: Oil Prices and Real Exchange Rates ●  33 changes in competitiveness compared to the respective export destination, as measured by the change in the bilateral real exchange rate between July 2014 and July 2015. A negative number indicates a real bilateral depreciation or an im- provement in competitiveness. Russia has experienced huge improvements in competitiveness in the non-oil sector, even if the relative costs are not yet back to levels before the oil price boom. As the mirror image, neighboring countries all lost competitiveness against Rus- sia, but they gained advantages in other export destinations, particularly Turkey and China. The real depreciations will also cause structural shifts within the domestic economies and again these shifts are reversals of what the countries experienced during the oil price boom. Demand for construction and nontradable services will decline and with that some of the jobs in these sectors will disappear. Often the less-experienced, less-skilled workers will lose their jobs first. Many of those had moved from rural areas into cities during the oil boom. Households experience rising costs of imports, while social security programs are under pressure. The next section will illustrate some of these shifts in domestic economies with model simulations of the shock in Russia, combining a computable general equilibrium (CGE) model with a microsimulation model. Simulating the Impact of Oil Prices on Inequality For oil-exporting countries, oil revenues are concentrated in a few companies and the government and, typically, only a small percentage of the total work force is employed in oil sector. In the case of Russia, the largest oil exporter of the region, less than 2 percent of the jobs are in the oil and gas sector. Nevertheless, the sharp decline in oil revenues deeply affects the structure of the whole economy and the income of all households through several channels. • For all households and all firms, real income declines as imports become more expensive. These terms-of-trade losses tend to be much larger than the losses due to reduction in production (GDP) and employment. • As a result of the income loss, demand for nontradable goods and services decreases, forcing a shift of jobs and activity out of construction, commerce, transport, and other nontradable services. This may create unemployment and underutilization of capacity. But even if new employment is created in tradable sectors, the shift may well affect relative wages and skill premia. It also may change wage differentials between rural and urban areas. • Asset prices, including real estate prices, will likely drop sharply. Moreover, those who have borrowed in foreign currency suddenly experience a rise in real debt. • Transfers from the government, which is facing shrinking oil royalties, may be under pressure. 34  ●   World Bank ECA Economic Update October 2015 These channels are also relevant for neighboring remittance-receiving coun- tries. Besides a drop in oil revenues, these countries experience a commensura- ble, or even larger, drop in remittance flows. This is because most migrant work- ers reside in oil-exporting countries. A reduction of jobs available to migrant workers or a reduction in the value of the remittances due to depreciated curren- cies causes the drop. Therefore the same spending, resource movements, and fiscal channels are at work. In addition, there may be a further drag on economic activity if these countries export mainly to oil-producing countries. Conversely, there may be some boost coming from savings on energy costs. Although the change in energy prices will affect everybody, the impact will likely affect some groups more than others. • Shrinking rents for oil companies and declines in asset prices will reduce per- sonal income disparities, as capital incomes are concentrated among rich households. • Workers losing jobs in shrinking sectors may not find another job or may have to move to informal or to lower-paid occupations. It is often the less-experi- enced and the less-skilled workers who are first to lose their job. This increas- es income inequality. • In general, sectoral shifts will change relative wages, depending on the factor intensity of the affected sectors—that is, whether they use more or fewer skilled services and whether they are located in urban or in rural areas. The nontradable sectors are more skill-intensive than the tradable ones. Therefore, a decline in oil prices will likely reduce the skill premium in labor markets. • The reduction of energy prices and the increased cost of imported consump- tion goods will have complex distributional consequences because of the op- posing forces at play. On balance, consumer prices increase less for richer households than for poorer households, mainly because richer households spend a relatively large part of their budget on real estate and nontradable services. To analyze at least some of these transmission channels, this section simulates the impact of the oil price shock for the Russian economy and Russian house- holds and the related reduction of remittance flows for the Kyrgyz Republic. The analysis makes use of sectoral general equilibrium models, which are linked to microeconomic simulation models. Consider first the case of Russia. One outcome of the simulation of a 50 per- cent reduction in the oil price is that per capita consumption is reduced by 6.9 percent, very similar to the actual terms-of-trade loss that Russia is suffering this year. The simulation suggests that the bottom 40 percent of households would reduce consumption by 6.2 percent and the top 60 percent by 7.0 percent (see ta- ble 2.2). Poverty rates rise for all the usual poverty lines. For example, when measured at the low line of US$2.5 a day, the oil shock increases poverty by drag- ging about 400,000 people below that line. At higher poverty lines, such as US$5 and US$10 per day, 2 million and 5.4 million additional people fall behind and poverty rates increase to 10 and 40 percent, respectively. Due to a slight progres- Chapter 2: Oil Prices and Real Exchange Rates ●  35 TABLE 2.2  Poverty Increases in the Russian Federation after Oil Prices Fall, 2011   Without oil shock With oil shock Change (%) Per capita consumption (US$) 6,364 5,927 −6.9 Bottom 40% 2,567 2,408 −6.2 Top 60% 8,896 8,272 −7.0 Poverty headcount (%) US$2.5 per day line 0.9 1.2 0.3 US$5 per day line 8.3 9.8 1.5 Sources: Household budget survey (HBS) data (2011) and microsimulation results. Note: Per capita consumption is expressed in 2005 U.S. dollar PPP; poverty headcounts are expressed in percent- ages. The column “Change” measures differences for per capita consumption as percentage change with respect to the baseline without shock, and percentage points differences for the poverty headcounts. sive impact (because richer people are affected slightly more than poorer ones), the Gini coefficient, a standard indicator of inequality, decreases marginally, from 41.1 to 40.9. Unskilled workers misplaced from jobs in nontradable services are among those who lose the most. The negative impact of the oil shock is slightly stronger for the richer than for the poorer households, as illustrated by the growth incidence curve (GIC); see the GIC labeled “Overall change” in figure 2.7. The figure shows that all households suffer, and there is a slight reduction in inequality. Apart from the average decline in income of 6.9 percent, the relative changes in income depend on various fac- tors. These include movement of workers from urban to rural labor market seg- ments, change in the returns to skills, and shifts in relative consumption prices. Some workers (mainly unskilled) will return from the urban employment to rural employment, which comes with a significant loss of income. However, the over- all regressive impact on income distribution is small, as shown by the GIC la- beled “Labor segment migration,” because it involves relatively few workers. The other factors have a much larger impact on the income distribution. FIGURE 2.7 Growth Incidence Curves –4 for the Oil Shock in the Russian Federation, –5 2011 (percent) GIC change (%) –6 Change in returns to skills + labor segment migration –7 Overall change: consumption relative prices + returns to skills + labor segment migration –8 Labor segment migration –9 0 20 40 60 80 100 Household income level (%) Sources: HBS data (2011) and microsimulation results. Note: The microsimulation is done in stages: first, workers move across segments; second, changes in relative factor prices are applied; third, changes in relative goods prices are applied. 36  ●   World Bank ECA Economic Update October 2015 Because of the reduced demand for nontradable products, which are skill-in- tensive, skill premia decline. This affects more the upper part of the distribution, where skilled workers are found (see figure 2.9), and it is reflected by the nega- tively sloped “Change in returns to skills” GIC. Finally, changes in relative consumption prices favor the rich and hurt the poor. As shown by the “Overall change” GIC, the change in consumption prices is less steep than loss of skill premia shown in the “Change in returns to skills” GIC. The changing consumer prices have several opposing effects. • Tradable manufactured products become relatively expensive as their import content is high. Richer households consume more manufactured products than poorer households. • Real estate and nontradable services become cheaper relative to other prod- ucts. These nontradables are an important part of the consumption basket of richer households. • Poorer households spend a relatively large part of their budget on agricul- tural products. These become more expensive relative to nontradable prod- ucts because agricultural products can easily substitute the more expensive imports. Agricultural product prices rise relative to other prices despite falling fertilizer costs, which are linked to lower energy prices. On balance, the relative rise of manufactured and agricultural products and the relative decline of real estate prices and prices of nontradable services benefit the rich and hurt the poor. Figure 2.8 shows that, in terms of output contraction, besides the oil sector, the hardest hit sectors in terms of employment are construction, transport and com- FIGURE 2.8 Sectoral Shifts Triggered 15 by Oil Price Decline Employment changes as share in the Russian Federation, 10 of total employment (%) 2011 (percent) 5 0 –5 –10 BusinessServ&PubAdmin –15 Food products Export manufacturing Other manufacturing Export agriculture Other mining Other agriculture Construction TranspTradeServ Oil Sector Sources: HBS data (2011) and microsimulation results. Chapter 2: Oil Prices and Real Exchange Rates ●  37 munication, other business services, and public services. Heavy job losses are recorded in the simulations for the construction and transport-communication service sectors, about 0.9 and 1.1 percent of total employment, respectively. These percentages, translated into actual levels of employment, represent close to 500,000 jobs lost in the construction sector and 700,000 jobs lose in the transport- communication sector. Import-competing industries and export-oriented sectors would benefit from the real depreciation and experience output expansions. A potential large gain is highlighted in the manufacturing sector, which may create close to 800,000 jobs. As discussed above, labor market shifts are the main reason why the income decline is not the same across the income distribution. Most of the expanding tradable sectors are less skill-intensive than the contracting nontradable ones. Therefore, the skill premium decreases. These skills are concentrated in richer households, as depicted in figure 2.9. This figure shows that even the intensity of the use of labor, the main source of income for most households, is not uniformly distributed. The bottom 40 percent of households record an average employment rate of 45 percent against an average of 53 percent for the top 60 percent of households. These differences are relevant because the simulation does not take into ac- count that public transfers may contract following the oil price shock. A reduc- tion in social government programs may hit poorer households harder, given their more intense dependency on transfers and lower employability. Furthermore, the additional jobs created in the expanding sectors are oppor- tunities that are realized in the general equilibrium model, but they may not necessarily be realized immediately in the real economy. As a thought experi- ment, an additional microsimulation was carried: all those who would lose their jobs in the contracting sectors—up to 3.1 percent of total employment—were un- able to find a new job and would become unemployed. Abstracting from multi- plier effects, what would be the distributional impact of this increase in unemployment? FIGURE 2.9 0.6 Unequal Distribution of Employment and Assets, 0.5 such as Human Capital, Employment changes as share across the Russian of total employment (%) 0.4 Population, 2011 (percent) 0.3 Total occupations Unskilled in nonagricultural 0.2 occupations Skilled in nonagricultural occupations 0.1 Skilled in agricultural occupations 0 0 20 40 60 80 100 Unskilled in agricultural occupations Household income level (%) Sources: HBS data (2011) and microsimulation results. 38  ●   World Bank ECA Economic Update October 2015 FIGURE 2.10 Equal Distribution of 14 Job Losses in the 12 Newly unemployed as a share of total new unemployed (%) Contracting Nontradable Sectors in the 10 Russian Federation, 8 Excepting the Top Decile, 2011 (percent) 6 4 2 0 1 2 3 4 5 6 7 8 9 10 Household income deciles Sources: HBS data (2011) and microsimulation results. An econometric estimation that takes into account the characteristics of the workers (and their households) was carried out to identify those who are most likely to lose their job.4 As expected, less-qualified, younger, and female workers are more likely to become unemployed. However, these individuals are found across the income distribution (see figure 2.10). Thus, vulnerability to becoming unemployed is not concentrated in a particular income group. The ultimate impact of unemployment vulnerability on income distribution would depend very much on the access new unemployed people have to insurance and transfer systems. More mechanisms are at work than can be captured by these model simula- tions. However, these simulations already show a pervasive impact for the Rus- sian economy and for Russian households. For the government, firms, and households alike it is important to recognize these sea changes. As mentioned above, the impact of oil prices is not limited to oil-exporting countries, but spreads to neighboring countries, especially through workers’ re- mittances. Consider in particular the case of the Kyrgyz Republic. This is the second most remittance-dependent country in the world, only after Tajikistan. A total of 77 percent of remittances to the Kyrgyz Republic come from Russia and their value equaled 30.3 percent of Kyrgyz GDP in 2014. For the first seven months of 2015, the inflow of remittances reported by the National Bank of Kyr- gyz Republic (NBKR) dropped by 22 percent in nominal U.S. dollar value com- pared with the same period of 2014. If this trend continues, the loss in remittances would be equivalent to 7.4 percent of the Kyrgyz GDP, more than double the drop in 2009. This is a major shock, similar in magnitude to the 6.9 percent drop in consumption recorded for the oil price shock in Russia. 4. Specifically, workers more likely to be unemployed are selected through a mul- tinomial probit estimation that computes the probability of either being em- ployed in tradable sectors, employed in nontradable sectors, or being unem- ployed according to individual and households characteristics. These characteristics include gender, education level, age, marital status, household size, living in urban or rural areas, and headship. Chapter 2: Oil Prices and Real Exchange Rates ●  39 TABLE 2.3  Poverty Increases in the Kyrgyz Republic after the Fall in Remittances, 2011   No remittance With remittance shock shock Change Per capita consumption (US$) 1,339 1,256 −6.2 Bottom 40% 777 726 −6.5 Top 60% 1,714 1,609 −6.1 Poverty headcount (%)   US$2.5 per day line 30.3 36.3 6.0 US$5 per day line 83.4 86.2 2.8 Sources: Kyrgyz Integrated Household Survey (KIHS) data (2011) and microsimulation results. Note: Per capita consumption is expressed in 2005 U.S. dollar PPP; poverty headcounts are expressed in percentages. The column “Change” measures differences for per capita consumption as percentage change with respect to the no shock case, and percentage points differences for the poverty headcounts. To account for the distributive impact of this remittance shock, a methodology combining a CGE model and a microsimulation model has been applied, as in the case of the Russian simulations. The main results are summarized in table 2.3. The remittance shock is large and it implies significant increases in the poverty headcount ratios. Welfare, measured by per capita consumption, decreases for all households but slightly more for the bottom 40 percent. The Gini coefficient mar- ginally increases from 27.8 to 27.9. Also in the Kyrgyz case, the real depreciation triggers resource reallocation toward tradables; and once again the skill and ur- ban premia are reduced, which implies that the richer part of the population is affected through this channel more severely. However, on balance the bottom 40 suffers larger losses than the top 60 and inequality increases. The overall impact is regressive because the change in remittances, unlike the change in oil revenues in the Russian case, directly affects a specific set of households. Households re- ceiving remittances are highly dependent on them and a large shock is likely to push many of them into poverty or toward the bottom 40 percent group, even if initially these households were in the middle of the distribution. When compared with those that did not receive remittances, households re- porting remittance receipts are, on average, more likely to have heads who are female, older, and less skilled. Remittance recipient households are also more likely to live in rural areas (79 percent), have a slightly higher dependency ratio, and have fewer remaining adults who are employed than nonremittance house- holds (see table 2.4). Despite all this, they were before the shock still relatively rich, thanks to the support from abroad. Indeed, remittances account for between 40 and 90 percent of the income of remittance households. Remittances are received by households across the entire welfare distribution, although they are slightly more concentrated in the middle groups. Deciles 4 to 7 all have between 14 and 15 percent of their households receiving remittances, while the richest and especially the poorest deciles register a much smaller share. As shown by the panel b of figure 2.11, at more than 50 percent, remittances rep- resent a very large share of income for recipient households. Given this high degree of dependence, the large decline in remittances pushes a large number of households who were, before the shock, in the middle of the distribution toward the poorer tail of the distribution. This explains why the 40  ●   World Bank ECA Economic Update October 2015 TABLE 2.4  Characteristics of Remittance and Nonremittance Households in the Kyrgyz Republic, 2011 Remittance Nonremittance households households Differences Household head female 0.35 0.30 0.05 Household head age 52.84 51.03 1.81 Household head skilled 0.24 0.31 −0.07 Urban 0.21 0.40 −0.19 Household size 4.91 4.77 0.15 Dependency ratio 0.80 0.71 0.10 Share of employed adults 0.42 0.56 −0.13 Consumption per capita 1,371 1,334 36.78 (2005 US$ PPP) Households 1.983 17,836 Source: KIHS 2011 and microsimulation results. FIGURE 2.11 a. Remittance recipients as share of population (%) The Importance of Remittances as a .16 Source of Income as share of population (%) across the Income .14 Remittance recipients Distribution in the Kyrgyz Republic, .12 2011 (percent) .1 .08 0 20 40 60 80 100 Share of total expenditure per capita (%) b. Remittances as share of income for recipients (%) .62 Remittances as share of total income (%) .6 .58 .56 0 20 40 60 80 100 Share of total expenditure per capita (%) Source: KIHS 2011 (questionnaire #6) and microsimulation results. Note: A kernel-weighted local polynomial regression was used to smooth the distribution. Expenditure includes durables, health, and imputed rents. Chapter 2: Oil Prices and Real Exchange Rates ●  41 FIGURE 2.12 –5 Dependence of the Distributional Impact –5.2 of the Remittance –5.4 Shock on the Anonymity –5.6 Distributional impact (%) Assumption in the –5.8 Kyrgyz Republic, 2011 –6 –6.2 Non-anonymous GIC –6.4 Anonymous GIC –6.6 –6.8 –7 0 20 40 60 80 100 Share of total expenditure per capita (%) Sources: HBS data (2011) and microsimulation results. anonymous bottom 40 indicator of table 2.3 shows a deterioration worse than that for the top 60, or why the anonymous GIC in figure 2.12 has a negative slope. This regressive impact disappears once the anonymity of the bottom 40 indi- cator is abandoned. If one controls for the composition of the people in the vari- ous deciles or, in other words, if one ‘follows’ individuals after the shock, then the incidence of the remittance shock appears to be more concentrated around the middle of the distribution, as shown in figure 2.12. Conclusions This chapter discussed the relationship in oil-exporting countries between oil prices and real exchange rates, using a simple theoretical model, econometric estimation, and large simulation models. The conclusions are that the relation- ship is strong in the oil-exporting countries, that the consequences of this strong relationship are pervasive, and that similar impacts are being felt in many neigh- boring countries. Reality is more complicated than can be captured in simple models. There are still many issues to be explored in more detail. Just a few of these include the impact of sovereign wealth funds, the impact on capital flows, the labor market consequences for the migrant workers, the vulnerabilities caused by dollariza- tion of financial sectors, and the adequacy of social safety nets. But it is already clear that the adjustment to the new normal poses many pol- icy challenges, from monetary and fiscal policy, to labor market and business climate policies. None of these challenges should lead to postponement of the adjustments. Such postponement would be very costly and would ultimately backfire. PART II Country Pages Macro Poverty Outlook Reports ●  45 Poverty is expected to continue on a slow ALBANIA Recent developments decline, as economic growth translates into job creation. Poverty ($5/day PPP) increased to 47.5 percent in 2012 from 45.2 Growth is accelerating in Albania, although percent in 2008, and is estimated to have it remains below the long-term trend. moderately declined to 46.7 percent in 2014 Growth picked up to 2.8 percent y/y in the 2014 with progress hindered by weaken- first quarter of 2015, driven by the rise in ing of labor markets in the past years with Population, million 2.9 private investment and improvement in the increases in the unemployment rate. Nev- GDP, current US$ billion 13.0 balance of trade; private consumption con- ertheless, labor markets are slowly picking GDP per capita, current US$ 4507 tracted and public sector expenditure re- up, particularly in sectors in which poorer Poverty rate ($2.5/day 2005 PPP terms) a 6.7 mained unchanged. Confidence in industry, individuals are often employed, including Poverty rate ($5/day 2005 PPP terms) a 47.5 b services and among consumers has been on agriculture and construction. The unem- Gini Coefficient 29.0 the rise, indicating continued momentum in ployment rate for the working age popu- c Life Expectancy at birth, years 77.4 the first half of the year. While oil exports lation slightly dropped from 17.7 percent Sources: World Bank, WDI, and M acro Poverty Outlook. fell in response to oil price developments, in the second quarter of 2014 to 17.3 per- Notes: (a) M ost recent value (2012) traditional Albanian exports such as textile cent in the second quarter of 2015, despite (b) Gini data show most recent WDI value (2012) (c) Life Expectancy data show most recent WDI value (2013) and shoes continued to increase. On the an increase in the labor force participation other hand increases in machineries and rate. Among younger workers, however, equipment drove the increase in imports, unemployment rose from 33.5 percent to thus supporting a more benign investment 34.2 percent in the same period, partly prospect. Inflation remains below target driven by an increase participation rate in Growth accelerated in 2015 and is ex- reflecting stagnant import prices, a persis- this age group. Given the gradual labor pected to continue an upward trajectory tent output gap. Growth estimates for 2015 market improvements this year, moderate were revised downward to 2.7 percent poverty ($5/day, 2005 PPP) is expected to over the next three years, albeit remaining (from 3 percent in the beginning of the stand at 46.1 percent in 2015. below potential. Improved business cli- year), due to the impacts of February’s Lower remittance inflows given recent mate and exports will drive this expansion floods on the agricultural sector and the events in Greece and slightly higher food and gradually reignite job creation, while reduction of oil production in response to inflation than overall inflation may be consumption, consumer confidence and external price developments, but are still affecting living standards, but likely not higher than 2014 (2.1 percent). Modest fiscal dramatically this year. Remittance inflows labor markets stabilize. Fiscal consolida- consolidation has taken place in the first declined from 11.7 percent of GDP in 2008 tion has so far fallen largely on expendi- half of 2015 with lower than expected reve- to 8.4 percent in 2014 due to economic tures as revenues underperformed, despite nues, conditioning a lower realization of conditions in the Eurozone. Though re- new tax measures. As employment im- expenditures, and capital expenditure in mittances represent a smaller source of particular. As a response, the government income for poor households, a reduction proves, gains in living standards are ex- has recently started a broad action against in inflows may contribute to slowing Al- pected with poverty continuing to decline. informality and tax evasion with which it bania’s overall economic activity and thus hopes to close the revenue gap. economic opportunities for households. FIGURE 1 Albania / GDP contribution by sector FIGURE 2 Albania / Actual and projected poverty rates and real GDP per capita, 2000-2017 70 12,000 15.0 60 10.0 10,000 50 5.0 8,000 Poverty Rate (%) GDP per capita 0.0 40 6,000 -5.0 30 4,000 -10.0 20 2010 2011 2012 2013 2014 2015 2016 2017 2,000 10 Private_consumption Government_consumption Gross_fixed_investment Exports_of goods_and_services 0 - 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Imports_of goods_and_services $2.5/day PPP $5/day PPP GDP per capita Sources: Instat. Sources: World Bank (see notes to Table 2). MPO 38 Oct 15 46  ●   World Bank ECA Economic Update October 2015 remittances inflows and no significant bania hampers productivity growth, tax Outlook changes in social protection benefits. The downward trend is expected to gradually revenue collections, and keeps regulatory compliance low. Increasing activity rates continue with poverty at 45.4 percent in and lowering unemployment, particularly The Albanian economy is expected to ex- 2016 and 44.7 percent in 2017. among youth and women, as well as im- pand by 3.4 percent in 2016 and by 3.5 Growth prospects for Albania hinge on proving the quality of employment across percent in 2017 albeit remaining below the implementation of the structural re- population groups, are enduring challeng- potential. Developments in Greece, slug- form agenda on energy, financial manage- es to lifting living standards. gish credit and labor markets and the ment of public investment, and pensions. Developments in Greece may have a larger slowing down of the reform momentum, Reforms in progress are expected to both than expected impact on Albania’s growth including fiscal consolidation, prevent promote growth and have positive distri- and poverty reduction prospects, through growth returning to a sustainable path. As butional effects. New pensions indexation reduced remittances, exports, investment. in 2015, for the next two years growth is rules and the introduction of a social pen- A prolonged crisis in Greece beyond the expected to be broad-based, driven by sion, as well as the focus on compensating baseline scenario, could further shock the both domestic and external demand. Net changes to energy tariffs through the ex- business and consumer confidence, the exports are expected to pick up following a isting social assistance program, are aimed labor markets and living standards of the gradual recovery in the EU. Improvement at protecting the real incomes of the poor population could be affected. In particular, of the business climate is expected to boost and less well-off. Albania would need to given the high number of Albanian mi- private investment, and consumption on a commit to a strong fiscal consolidation in grants and/or seasonal workers to Greece, medium-term horizon, despite the impact the medium term for its debt to return to a remittances inflows could decrease from of the debt crisis in Greece on remittances, sustainable path. an already depressed level since the wake exports and the credit market. of the 2008 crisis. As the economy gradually accelerates, Moving forward, Albania faces the chal- further albeit slow declines in poverty are expected. Following the expected broad- Challenges lenge of resiliently sustaining economic growth and creating jobs, while ensuring based economic growth patterns, contin- that the poor and vulnerable are ade- ued improvements in employment rates Persistently weak labor markets limit the quately protected. across sectors will likely drive the modest potential of the Albanian economy. A high changes in poverty, given persistently low rate of informality in employment in Al- TABLE Albania / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 1.6 1.1 2.1 2.7 3.4 3.5 Private Consumption 0.1 1.4 3.4 -0.7 2.0 1.9 Government Consumption 0.1 2.9 8.7 1.1 3.3 0.8 Gross Fixed Capital Investment -7.9 -2.1 -2.2 8.2 8.0 8.4 Exports, Goods and Services -0.6 7.9 -13.1 -1.5 7.6 6.1 Imports, Goods and Services -6.6 5.0 -7.7 -3.6 6.2 4.8 Real GDP growth, at constant factor prices -0.2 1.5 1.7 3.0 4.4 5.2 Agriculture 5.4 0.7 2.0 1.8 3.1 3.8 Industry -12.1 5.3 -4.9 1.6 10.8 12.1 Services 3.2 0.3 4.3 4.1 2.5 3.0 Prices Inflation (GDP price deflator) 1.4 -1.0 0.4 2.4 2.9 3.0 Inflation (Consumer Price Index) 2.0 1.9 1.6 2.9 2.5 2.9 Current Account Balance (% of GDP) -10.2 -10.7 -13.0 -13.1 -13.4 -12.6 Fiscal Balance (% of GDP) -3.4 -5.2 -5.8 -5.1 -2.3 -0.2 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 6.7 6.6 6.3 6.1 5.8 5.5 Poverty rate ($5/day 2005 PPP terms) 47.5 47.2 46.7 46.1 45.4 44.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2002-LSM S and 201 2-LSM S. (b) P ro jectio n using annualized elasticity (2002-201 with pass-thro ugh = 1based o n GDP per capita co nstant P P P . 2) � (c) A ctual data: 201 2. Estimates fo r 2013 thro ugh 2014, pro jectio ns are fro m 2015 to 2017. MPO 39 Oct 15 Macro Poverty Outlook Reports ●  47 policy rate has been cut by a cumulative ARMENIA Recent developments 25 basis points since February 2015 from a historic high of 10.5 percent. A steep decline in exports and remittances Real GDP grew by 3.7 percent, year-on- has weakened the external account, year (y/y) in the first half of 2015. Good though import compression partially off- 2014 agricultural conditions and the opening of set this effect. The current account deficit Population, million 3.0 the new copper mine more than offset the expanded from 7.3 percent of GDP in 2014 GDP, current US$ billion 11.6 poor performance of other sectors, particu- to 17 percent in the first quarter of 2015. GDP per capita, current US$ 3898 larly manufacturing, retail and real estate. After declining steadily for the past sever- Poverty rate($2.5/day 2005PPP terms) a 30.2 The government’s fiscal position has dete- al years the poverty rate (at US$2.50 per Poverty rate($5/day 2005PPP terms) a 78.4 riorated, as strong growth in the first half day) plateaued at 30.2 percent in 2014, still of the year did not translate into higher above its pre-crisis level. Gains in poverty Gini Coefficient b 30.3 revenues due to the largely tax-exempt reduction have been driven by robust ag- Life Expectancy at birth, years c 74.4 nature of the agricultural sector. Increased ricultural output and by higher employ- Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: budgetary lending and defense outlays are ment and earnings in the nonagricultural (a) M ost recent value (2013) putting upward pressure on public ex- sectors. Remittances and pension pay- (b) Gini data show most recent WDI value (2012) (c) Life Expectancy data show most recent WDI value (2013) penditures, as is the introduction unbudg- ments supported consumption growth eted subsidies to compensate households among households in the lower end of the and small businesses for increased electric- income distribution. ity tariffs. As a result, the fiscal deficit wid- In 2015, however, slowing domestic eco- ened from 1.9 percent of GDP in 2014 to 3 nomic activity and the weakening of the Despite its strong performance during the percent in the first half of 2015. Russian labor market has hindered pov- The Armenian dram has depreciated by erty reduction. Falling remittances are first half of 2015 , Armenia’s economy is 17 percent against the US dollar since No- expected to negatively impact the welfare expected to slow significantly in the sec- vember 2014, prompting the central bank of households at all income levels. Rough- ond half of the year. GDP growth is pro- to intervene in the foreign-exchange mar- ly 40 percent of households in the bottom jected to fall from 3.4 percent in 2014 to ket. However, the real effective exchange quintile receive remittances, which equal rate has appreciated due to the sharp de- about 5 percent of their aggregate house- 2.1 percent in 2015 due to the spillover cline in relative currency values among hold consumption. effects from the Russian recession and low Armenia’s main trading partners, particu- Russia’s declining demand for migrant prices for Armenia’s key export commodi- larly Russia, as the ruble has depreciated workers is not only curbing remittances ties. Moderate progress in reducing pov- by 80 percent against the US dollar since but also prompting Armenian workers to erty and promoting shared prosperity November 2014. At end-July 2015 the return to the domestic labor market, dram’s real effective exchange rate was up which is putting upward pressure on the during 2010-14 could be reversed by a 7.5 percent from a year earlier. unemployment rate. Unemployment in combination of low growth, rising elec- After reaching 5.8 percent in March, 12- Armenia rose from 17.6 percent in 2014 to tricity tariffs and deteriorating prospects month inflation declined to 3.6 percent in 19.1 percent in March 2015. Falling re- for migration and remittances. August, allowing the central bank to loos- mittances and weakening labor markets en its monetary policy stance. The key combined with rising inflation and limited FIGURE 1 Armenia / GDP Growth by Sector, 2009-2015 FIGURE 2 Armenia / Actual and projected poverty rates, 2001-2017 Percent 100 4.0 90 80 2.0 70 0.0 60 2009 2010 2011 2012 2013 2014 2015e -2.0 50 -4.0 40 Industry -6.0 30 Agriculture Construction 20 -8.0 Services 10 -10.0 Net taxes 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -12.0 -14.0 $2.5/day PPP $5/day PPP Source: Armenia Statistical Service. Sources: World Bank (see notes to Table 2). MPO 40 Oct 15 48  ●   World Bank ECA Economic Update October 2015 fiscal space for countercyclical spending The fiscal deficit is projected to widen to 4 are preventing further progress in poverty reduction. percent of GDP in 2015 and will be fi- nanced fully by external borrowing. The Challenges government’s fiscal position should im- prove as the economy gradually strength- Sustaining growth in the face of a worsening Outlook ens. However, the public debt stock will continue to rise, and fiscal consolidation external environment with limited space for fiscal stimulus will pose a serious challenge efforts, especially on the revenue side, will to Armenian policymakers. The relative ap- GDP growth is expected to reach just 2.1 be necessary to ensure fiscal sustainability. preciation of the Armenian dram against the percent in 2015 as a worsening external The poverty rate is expected to remain Russian ruble could further constrain growth environment takes toll in the second half broadly unchanged at about 30 percent by reducing the competitiveness of Armeni- of the year. With the Russian economy through 2017. Low growth, increasing an exports. However, a potential normaliza- projected to contract and base metal prices unemployment, weaker remittance flows tion with Iran over its nuclear program could expected to remain low, GDP growth in and rising electricity tariffs will continue facilitate increased trade and enable Iran to Armenia is expected to average 2-3 per- to negatively impact household welfare serve as a transit route for shipping Armeni- cent per year over the medium term. over the medium term. an goods to the Middle East and Asia. TABLE Armenia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 7.2 3.3 3.5 2.1 2.7 3.0 Private Consumption 7.7 2.8 0.2 -1.5 2.4 1.7 Government Consumption -1.4 16.3 -0.9 -14.3 -12.1 0.6 Gross Fixed Capital Investment -1.9 -7.9 -8.0 1.6 2.4 5.8 Exports, Goods and Services 8.4 16.3 22.6 6.0 2.7 1.6 Imports, Goods and Services -2.8 0.7 7.7 -6.4 0.4 2.6 Real GDP growth, at constant factor prices 7.1 3.6 4.1 2.4 2.8 3.1 Agriculture 9.5 7.6 7.8 6.3 4.0 4.0 Industry 5.2 0.8 -0.8 0.7 2.5 4.1 Services 7.2 3.2 5.5 0.6 2.0 1.5 Prices Inflation (GDP price deflator) 5.3 3.4 2.7 3.1 3.3 3.7 Inflation (Consumer Price Index) 2.6 5.8 3.0 5.6 3.1 4.0 Current Account Balance (% of GDP) -10.0 -7.6 -7.3 -7.3 -6.5 -5.7 Fiscal Balance (% of GDP) -1.4 -1.6 -1.9 -4.0 -3.3 -2.7 a, b, c Poverty Rate Poverty rate ($2.5/day 2005PPP terms) 30.1 30.2 30.2 30.2 30.3 30.3 Poverty rate ($5/day 2005PPP terms) 79.6 78.4 78.2 78.0 77.8 77.6 Sources: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2009-ILCS and 201 3-ILCS. (b) P ro jectio n using P o int-to -po int elasticity (2009-201 with pass-thro ugh = 0.7 based o n GDP per capita co nstant P P P . 3) � (c) A ctual data: 201 2. Data fo r 201 3-4 are estimates, data fro m 2015 thro ugh 201 7 are pro jectio ns. MPO 41 Oct 15 Macro Poverty Outlook Reports ●  49 gust, prompting the central bank to draw AZERBAIJAN Recent developments down its foreign-exchange reserves by US$1.2 billion. Exchange rate uncertainty encouraged dollarization, and the share of Despite a turbulent external environment foreign-exchange deposits nearly doubled Azerbaijan’s GDP growth accelerated to to 71 percent. Prices increased in March 2014 5.7 percent in the first half of 2015 as agri- 2015, following the devaluation, but gov- Population, million 9.5 culture and non-oil manufacturing rapidly ernment intervention, including increased GDP, current US$ billion 75.2 expanded. Although oil production fell in oversight of wholesale and retail trade GDP per capita, current US$ 7921 2015, an increase in refining capacity companies, along with a contraction of the Gini Coefficient a 33.0 boosted total oil-sector output by 0.6 per- money supply, has kept inflation relatively Life Expectancy at birth, years b 70.6 cent, y/y. Meanwhile, non-oil GDP grew low in subsequent months. As a result, by 9.2 percent in the first half of the year, consumer prices increased by a moderate Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: fueled by public investment related to the 4.4 percent in the first half of the year. (a) Gini data show most recent WDI value (2008) (b) Life Expectancy data show most recent WDI value (2013) European Games, the Trans-Anatolia Nat- Poverty rates in Azerbaijan have steadily ural Gas Pipeline (TANAP) and ongoing declined over the past decade (Figure 2), as projects in the Shah Deniz gas field. Agri- consumption among households in the culture and non-oil manufacturing, in- lower end of the income distribution has cluding food-processing, chemical pro- steadily increased. According to official Growth accelerated to 5.7 percent, year- duction and construction materials, also statistics the national poverty headcount experienced robust growth. rate continued to fall from 6 percent in on-year (y/y), in the first half of 2015, In the first quarter of 2015 the current ac- 2012 to 5 percent in 2014 despite slowing driven by public investment and the count surplus plunged to 0.4 percent of economic growth. The extreme poverty GDP due to a steep decline in oil prices rate, measured according to the interna- robust performance of the agricultural and increased imports in preparation for tional poverty line of US$1.25 per person and non-oil manufacturing sectors. the European Games. Oil revenues fell by per day, is below the World Bank’s global However, the decline in value of oil ex- 38 percent in the first half of the year, sig- target of 3 percent by 2030. However, the nificantly weakening the fiscal balance. official poverty statistics for 2013-2014 ports caused the current-account sur- Consolidated expenditures (including the have not been verified by the World Bank. plus to narrow sharply and pushed the State, Nakhchivan autonomous region, the State Oil Fund and the Social Protec- budget balance into deficit. The Azer- baijani manat stabilized following a 34 tion Fund) remained stable compared with the past year, but consolidated reve- Outlook nues dropped substantially. However, percent devaluation in February. Slow- growth in the non-oil sector led to a 10 Economic growth is projected to average ing growth and rising inflation in the percent growth in non-oil revenues. 2.4 percent per year over 2015-17, as oil wake of the manat’s devaluation are After a 34 percent devaluation against the production continues to decline and lower US dollar in late February the manat has oil revenues constrain public spending. likely to increase poverty rates. remained relatively stable. However, de- Falling oil exports are projected to reduce preciation pressures intensified in late Au- the current account surplus to 5.2 percent FIGURE 1 Azerbaijan / GDP Growth Decomposition, 2008- FIGURE 2 Azerbaijan / National poverty rate, 2001-2014 2014 20.0 60 50 10.0 40 0.0 30 -10.0 20 -20.0 10 2008 2009 2010 2011 2012 2013 2014 e Net exports Residual items 0 Change in inventories Gross fixed capital formation Final comsumption GDP growth Sources: Government of Azerbaijan and Bank staff calculations. Source: State Statistical Committee calculations. Notes: Poverty lines set by government yearly (AZN125 for 2013). MPO 42 Oct 15 50  ●   World Bank ECA Economic Update October 2015 of GDP over the medium term. Moreover, prices gradually recover and the govern- economy has been largely driven by pub- the weakening of the Russian economy ment consolidates its expenditures. lic spending and investment financed by presents an important downside risk, as After a modest rise in 2015, inflation is oil revenues. Russia accounts for one-third of Azerbai- projected to fall below 5 percent per year Weaknesses in the financial sector pose a jan’s non-oil exports. over the medium term. significant challenge, as increased dollari- Public investment is projected to fall to an While data limitations do not allow for zation is constraining the supply of credit. average of 10.3 percent of GDP between poverty projections, sustaining the pace of In addition, a further deterioration in re- 2015 and 2017, reducing non-oil GDP poverty reduction over 2015-16 will be gional economic conditions could increase growth to less than 4 percent per year. How- challenging in a context of slow growth, pressure on the exchange rate. ever, investment in the hydrocarbons sector falling oil revenues and lower rates of Despite slowing growth, the government will significantly increase in 2016-17 due to public investment. intends to protect vulnerable households the construction of major gas pipelines. and safeguard its achievements in poverty The consolidated fiscal deficit is projected reduction. However, given a shrinking to average 1.4 percent of GDP over the medium term. A deficit of 3.4 percent of Challenges resource envelope, re-orienting spending towards greater efficiency is needed to GDP is anticipated in 2015, reflecting the generate the necessary fiscal space. impact of low oil prices and a one-off in- Low oil prices and declining oil output crease in public investment. This deficit is remain the most salient risks to Azerbai- expected to narrow over 2016-17 as oil jan’s growth prospects, as the country’s TABLE Azerbaijan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 2.2 5.8 2.8 2.0 2.6 2.7 Private Consumption 2.2 8.1 8.5 5.5 3.2 3.0 Government Consumption 2.2 9.0 4.0 -4.6 -5.4 -5.0 Gross Fixed Capital Investment 2.2 19.4 -2.1 -3.6 2.2 3.9 Exports, Goods and Services 2.2 1.5 -2.5 -1.0 -0.6 -0.7 Imports, Goods and Services 2.2 10.0 1.1 -3.6 -2.5 -2.0 Real GDP growth, at constant factor prices 0.8 5.2 2.6 2.8 2.2 2.1 Agriculture 6.6 4.9 -2.4 6.0 4.2 4.0 Industry 18.6 1.8 0.5 2.0 1.5 1.4 Services -30.6 15.1 9.6 3.8 3.5 3.2 Prices Inflation (GDP price deflator) 2.8 0.5 -1.4 -6.1 5.9 4.9 Inflation (Consumer Price Index) 1.1 2.5 1.5 7.5 4.1 4.1 Current Account Balance (% of GDP) 21.5 16.5 13.8 2.9 5.5 7.4 Fiscal Balance (% of GDP) 3.7 1.7 2.7 -3.4 -1.1 0.7 Sources: World Bank, M acroeconomics and Fiscal M anagement Global Practice, and Poverty Global Practice. Note: f = forecast. MPO 43 Oct 15 Macro Poverty Outlook Reports ●  51 percent for the year in order to reach an BELARUS Recent developments inflation rate of 18±2 percent. Even though monetary growth was higher than target- ed since February, in January-July 2015 The Belarussian economy is in recession the inflation rate was below the lower with real output contracting for the first bound of the band at 14.9 percent 2014 time since 1995. In January-July 2015, real (compared to 17.5 percent a year ago). Population, million 9.4 GDP dropped 4 percent y/y, compared to Since mid-2014, the exchange rate policy GDP, current US$ billion 76.1 a modest increase of 1.6 percent y/y in the has mainly responded to deteriorating GDP per capita, current US$ 8074 same period in 2014. Industrial output fell conditions in Russia. The Belarusian rubel Gini Coefficient b 27.5 by 7.2 percent y/y, with all subsectors but (BYR) depreciated against the USD by 23 Life Expectancy at birth, years c 73.2 chemicals shrinking and some by a large percent in January 2015, and another 19 Sources: World Bank, WDI, and M acro Poverty Outlook. magnitude. A late start of the harvesting percent from late May to late August. Notes: (a) M ost recent value (2012) season at end-July instead of earlier in the Competitiveness relative to regional part- (b) Gini data show most recent WDI value (2011) (c) Life Expectancy data show most recent WDI value (2013) month led to a decline in agricultural out- ners, however, remains an issue: inflation put by 11.5 percent y/y. Lower growth in Belarus is larger than in Russia and, in and persistent inflation reduced real wag- addition, the BYR appreciated against the es and incomes, thus leading to a fall in Russian ruble (RUR) by about 8 percent in private consumption by 0.5 percent y/y in nominal terms since mid-2014. The Belarus economy is in recession the first quarter. Gross fixed capital invest- Foreign trade and current-account imbal- due to an adverse external environ- ments continued contracting—with a re- ances are narrowing because of lower duction of 14.6 percent y/y (on top of the demand for imports and the exchange rate ment with falling exports and a sharp 9.1 percent y/y drop observed a year ago), depreciation, but Belarus still faces large depreciation of the Russian ruble. To led by downscaling of public capital ex- external financing requirements. During penditures and some compression of di- the first half of 2015, imports of goods and preserve already low foreign exchange rected lending services decreased by 27.6 percent y/y in reserves, the authorities tightened Labor market outcomes worsened with the dollar value, more than exports that de- monetary and fiscal policies and al- recession. In July 2015, employment de- clined by 24.3 percent y/y. Shrinking mar- creased by 1.5 percent y/y, while the num- kets and the RUR depreciation hit sales of lowed for greater exchange rate flexi- ber of officially registered unemployment goods to Russia, which fell by 33.3 percent bility, while seeking to refinance the more than doubled. In January-June 2015, y/y in dollar value. Current account deficit growing foreign public debt. Over the 7.7 percent of the active labor force worked stood at 5.2 percent of GDP in January- reduced hours (compared to only 3.1 per- May 2015—almost half of what it was a medium term, economic growth is cent a year ago), and 5.1 percent of work- year ago. In the first seven months of 2015, likely to remain low—given expecta- ers were affected by temporary production the Government paid USD 1.6 billion of tions for modest recovery in Europe stoppages in the firms employing them. foreign debt, and nearly half of this sum At the beginning of 2015, the National was refinanced using new loans disbursed and weakness in Russia—unless Bank of Belarus (NBRB) adopted a base- by Russia. Foreign reserves, excluding structural reforms are undertaken. money targeting regime, setting a nominal gold, declined by 16 percent since the be- broad money supply growth target at 30 ginning of 2015, and by August stand at FIGURE 1 Belarus / Contributions to quarterly GDP Growth FIGURE 2 Belarus / Daily currency dynamics, index values (1/1/2014=1) 25 2.2 20 2.1 2.0 15 1.9 BYR/USD 1.8 BYR/RUR 10 1.7 1.6 RUR/USD 5 1.5 0 1.4 1.3 -5 1.2 1.1 -10 1.0 -15 0.9 0.8 Q4/10 Q1/12 Q2/13 Q3/14 Q1/10 Q2/10 Q3/10 Q1/11 Q2/11 Q3/11 Q4/11 Q2/12 Q3/12 Q4/12 Q1/13 Q3/13 Q4/13 Q1/14 Q2/14 Q4/14 Q1/15 0.7 0.6 0.5 Residual item Net Exports Gross Capital Formation 11/1/2014 10/1/2014 12/1/2014 1/1/2014 2/1/2014 3/1/2014 4/1/2014 5/1/2014 6/1/2014 7/1/2014 8/1/2014 9/1/2014 1/1/2015 2/1/2015 3/1/2015 4/1/2015 5/1/2015 6/1/2015 7/1/2015 8/1/2015 9/1/2015 Total Consumption Real GDP Growth Source: World Bank Staff Estimates based on the National Statistical Committee Source: National Bank of Belarus, Central Bank of Russia. Data. MPO 44 Oct 15 52  ●   World Bank ECA Economic Update October 2015 USD 2.85 billion, barely covering one further adjust output and the real exchange excessive state intervention in the econo- month of imports of goods and services. rate to close the BOP gap. Exchange rate my, poor SOEs performance, weak inter- fluctuations, along with planned increases national competitiveness, and macroeco- in utility tariffs, will keep inflation in dou- nomic imbalances. A return to growth will Outlook ble-digit territory. The current account defi- cit is expected to narrow modestly to 3-4 be possible if Belarus implements critical structural reforms. There is consensus that percent of GDP, reflecting the difficulties to boosting productivity is a key to restoring Belarus’ economic outlook for 2015 re- attract external financing. growth; nevertheless, the policy focus so mains bleak, with real GDP projected to If the authorities undertake macroeconomic far has been on state-led technological decline by 3.5 percent. Domestic demand adjustment and structural reforms, support- upgrading of selected manufacturing sec- is likely to remain weak, with declining ed by international financing, growth may tors, with much less attention to other investment and consumption, and the initially be lower in 2016, but prospects of a aspects of enterprise performance. In the current account deficit is expected to nar- recovery in 2017 are stronger. Admittedly, complex environment, shaped by external row to 4.2 percent of GDP. Additional the outlook for 2016 and 2017 is subject to pressures and an electoral cycle at home, official financing assistance has been re- uncertainty related to oil prices, the devel- growth can be spurred by appropriately quested from the Eurasian Fund for Stabi- opments in Russia and Ukraine. Progress sequenced reforms supported by interna- lization and Development (EFSD) of the on a comprehensive structural reform agen- tional partners and investors. In any case, EurAsEC and Russia to support interna- da would also affect outcomes the backbone of change is to break the tional reserves at the NBRB and to meet barriers to doing business more efficiently public foreign debt obligations falling due as resources are locked-in less productive in the next few months—nearly USD2.2 billion to be repaid from August to De- Challenges uses by SOEs, supported by subsidized loans and granted with debt rescheduling. cember 2015. This short-sighted policy needs to be For 2016 and 2017, the outlook is predicated The major challenge is to avoid falling into changed if Belarus is to return to a sus- upon the persistence of limited access to a low-growth equilibrium because of long tainable growth path in the future. foreign financing and thus the necessity to -standing structural problems, including TABLE Belarus / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 1.7 1.1 1.6 -3.5 -0.5 1.0 Private Consumption 10.7 10.8 4.4 -3.0 -1.4 1.5 Government Consumption -1.0 -2.1 -1.9 -2.0 -0.5 0.0 Gross Fixed Capital Investment -11.3 9.6 -8.9 -12.3 -0.7 1.7 Exports, Goods and Services 11.2 -16.0 -3.6 -14.0 -1.0 2.0 Imports, Goods and Services 10.9 -4.2 -7.4 -15.0 -2.0 2.5 Real GDP growth, at constant factor prices 1.3 0.5 1.7 -3.8 -0.5 1.1 Agriculture 6.4 -3.8 3.9 1.0 2.0 2.0 Industry 2.0 -2.0 0.5 -7.0 -1.1 1.0 Services -1.1 5.2 2.5 -1.3 -0.5 1.0 Prices Inflation (GDP price deflator) 75.4 21.1 18.1 17.4 17.8 14.9 Inflation (Consumer Price Index) 59.1 18.3 18.3 16.5 15.5 14.5 Current Account Balance (% of GDP) -2.9 -10.4 -6.8 -4.2 -3.2 -3.9 Fiscal Balance (% of GDP) 1.7 0.1 1.1 1.8 0.1 0.2 Sources: World Bank, M acroeconomics and Fiscal M anagement Global Practice, and Poverty Global Practice. Note: f = forecast. MPO 45 Oct 15 Macro Poverty Outlook Reports ●  53 effect on poverty reduction or on boosting BOSNIA AND Recent developments shared prosperity, as very few poor or Bottom 40 households are employed there. Deflation moderated in the first half of HERZEGOVINA High frequency data for the first half of 2015 point to an acceleration in economic 2015 with consumer prices falling by 0.5 percent year-on-year in the first half of activity. First official estimates show GDP 2015 (versus a fall of 1.5 percent a year growth of 2.1 percent year-on-year in the earlier). The biggest drivers to the fall first quarter, mainly driven by construc- came from the prices of imported goods, 2014 tion and services. Stronger indirect reve- including oil, food, clothing and footwear. Population, million 3.8 nue collection also points to recovering This trend will benefit low income house- GDP, current US$ billion 16.8 domestic demand. Industrial production, holds primarily in urban areas but for GDP per capita, current US$ 4769 in decline during 2014 following the floods agricultural producers it will may be off- of May that year, has also recovered, mov- set by the negative effect of lower food Gini Coefficient a 33.4 ing to positive growth by March 2015, and prices; a large share of the poor reside in Life Expectancy at birth, years b 76.3 reaching 4.3 percent year-on-year in June. rural areas, and poverty incidence among Sources: World Bank, WDI, M acro Poverty Outlook, and BHAS. The 2014 floods hit agriculture and energy those in the agricultural sectors is high. Notes: (a) Gini data show most recent WDI value (2007) output the most, contributing to the fall in In the second quarter of 2015 the converti- (b) Life Expectancy data show most recent WDI value (2013) growth to 0.8 percent in 2014. ble mark - pegged to the Euro under the Slow progress in advancing reforms con- currency board arrangement weakened tributed to an unchanged, and high, un- moderately against the dollar but as of employment rate (27 percent in 2015) and July was still down 12 percent relative to constant gross earnings over 2014 to 2015. December 2014 following the marked de- High frequency indicators suggest some Youth unemployment was an extremely preciation earlier in 2015. As a result, com- recent pick-up in activity. Growth in high 62 percent in 2014. Much of the in- bined with falling domestic prices, the real 2015 overall is likely to recover to 2 per- crease in employment seen in early 2015 (a effective exchange rate weakened by 4 1.7 percent rise in the first quarter from a percent from December 2014 to July 2015. cent, supported by reconstruction after year earlier) originated in public admin- Risks of adverse balance sheet effects from the 2014 floods and improving external istration. the dollar strengthening is limited by the demand. With still-weak labor dynamics, The stalling in recent years of the pre- modest share of dollar-denominated ex- the poverty headcount is likely to improve crisis poverty reduction trend reflects the ternal debt (about 16 percent). strong relationship of poverty (and shared After the delayed adoption of the 2015 only marginally. A joint agreement be- prosperity) to labor market performance, budget by the BH institutions, following tween the national and sub-national au- especially in sectors that employ lower the protracted time for government for- thorities on the country’s priority reform skilled workers. The poor (and the bottom mation in FBH and BH Institutions, the agenda was signed in July 2015. Imple- 40) are disproportionally low skilled and Fiscal Council came to an agreement on mentation of this agenda, including long- unemployed, or employed in low-skilled the fiscal framework for 2016-2018 at the occupations and sectors. The recent in- end of June 2015. After the delayed adop- awaited labor reforms, is key to an im- creases in employment in public admin- tion of the 2015 budget by the BH institu- proved medium-term outlook. istration, for example, will thus have little tions, following the protracted time for FIGURE 1 Bosnia and Herzegovina / Contributions to an- FIGURE 2 Bosnia and Herzegovina /Growth incidence nual GDP growth curve, 2007-2011 in percent Private_consumption 15.0 Government_consumption 10.0 Gross_fixed_investment Net exports 5.0 GDP 0.0 -5.0 -10.0 -15.0 2007 2008 2009 2010 2011 2012 2013 2014f Source: BH Agency for Statistics (BHAS), World Bank staff estimates. Source: World Bank, BHAS, FBO and RSIS (2015). Poverty and inequality in BH 2007-2011. World Bank Report No. 97643. MPO 46 Oct 15 54  ●   World Bank ECA Economic Update October 2015 government formation in FBH and BH wages are expected to remain largely flat. given the high tax wedge on labor, espe- Institutions, the Fiscal Council came to an The drought this year is also likely to have cially among low-wage workers. This agreement on the fiscal framework for a negative effect on rural households em- makes it difficult for employers to create 2016-2018 at the end of June 2015. ployed in agriculture, especially among formal jobs for lower skilled workers, re- smaller (and poorer) farmers, who are less sulting in persistent unemployment, un- able to insure against negative shocks. deremployment and a high degree of in- Outlook Overall, the poverty headcount is likely to improve only marginally. In the medium formality, especially among the poor and in the Bottom 40 group. One of the possi- term, the impact of the projected rise in bilities is to support formalization of em- Growth is projected to strengthen to 2 growth on poverty reduction and im- ployment via the new labor code legisla- percent in 2015 and to further rise in the proved shared prosperity will depend tion currently being adopted in FBH and medium-term. Near-term support will critically on the creation of new jobs. which is going through consultations with come from the recovery in external de- social partners in the Republika Srpska. mand and the stepping up of reconstruc- The social protection system remains tion after the 2014 floods. Unless ad- dressed, the slow implementation of long- Challenges poorly targeted, with virtually no effect on the poverty headcount, and improving standing reforms will continue to be coverage and targeting will be required dampen medium-term growth. Other The challenge for fiscal policy will be to alongside labor market reforms to ensure risks to the outlook include possible de- secure medium-term sustainability while an effective safety net. lays in Europe’s recovery which would supporting the needed recovery in Having recently signed the Reform Agen- have an impact on exports, remittances growth. Fiscal consolidation will need to da, the authorities now face the challenge and capital flows. The 2015 fiscal deficit is be gradually introduced in order to absorb of delivering on the reforms at the core of projected to remain around 2 percent of the shock caused by the floods. The sus- the agenda. Besides helping strengthen GDP, as in the two previous years, with tainability of public debt needs to be potential growth and supporting im- fiscal consolidation to be gradually intro- closely monitored as its scope, size and proved living standards, reform imple- duced in order to absorb the shock caused complexity has increased. In addition, mentation will be essential for sustaining by the floods. particular focus will be needed on docu- EU integration. In turn, the adoption and Unemployment, particularly among mentation of the arrears, full accounting implementation of reforms in key areas, youth, is expected to remain high, with of which does not exist. from the labor market to management of some improvement in employment as Reducing unemployment, while maintain- fiscal spending, will depend crucially on activity picks up. However, the private ing macroeconomic stability will require political dynamics. sector remains constrained by the high tax an ambitious policy agenda. A persistent burden, which constrains hiring. Real challenge is the high cost of employment, TABLE Bosnia and Herzegovina / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 0.9 2.0 2.1 3.2 Private Consumption 1.0 1.4 2.8 3.0 Government Consumption 1.4 1.7 2.5 2.8 Gross Fixed Capital Investment 2.9 3.7 3.0 2.5 Exports, Goods and Services -1.8 2.4 4.0 4.0 Imports, Goods and Services 0.3 1.8 3.5 3.0 Real GDP growth, at constant factor prices -1.2 2.5 0.8 1.9 2.3 3.1 Agriculture -11.4 15.8 -9.6 -2.0 2.5 3.0 Industry -2.5 3.5 -1.6 2.9 3.0 3.3 Services 0.7 0.5 3.2 2.0 2.0 3.0 Prices Inflation (GDP price deflatior) 2.6 0.8 2.4 -0.7 -0.6 0.9 Inflation (Consumer Price Index) 2.0 -0.1 -0.9 -0.4 .. .. Current Account Balance (% of GDP) -8.9 -5.7 -7.6 -7.9 -6.0 -6.5 Fiscal Balance (% of GDP) -2.0 -2.2 -2.1 -1.9 -1.8 -1.7 Source: Wo rld B ank. No te: f = fo recast. MPO 47 Oct 15 Macro Poverty Outlook Reports ●  55 which declined by 1.1 percent in July 2015 Recent developments on an annual basis. These pressures were BULGARIA somewhat dampened compared to 2014 due to increases in administrative prices, Supported by exports and investment, depreciation of the Lev against the US GDP grew by 2.4 percent year-on-year in dollar, and rising unit labor costs. 2014 Q2-2015. Exports were boosted by eco- The external current account turned into Population, million 7.3 nomic recovery in the Eurozone while in a small surplus in the first half of 2015 GDP, current US$ billion 55.7 investment, mainly public, expanded in from a small deficit a year earlier. The GDP per capita, current US$ 7630 line with intensified implementation of trade deficit narrowed significantly, sup- Poverty rate ($2.5/day 2005 PPP terms) a 5.6 EU-funded projects. Consumption con- ported by robust export growth. Exports Poverty rate ($5/day 2005 PPP terms) a 16.4 tributed to growth but its contribution expanded by 12.6 percent year-on-year b Gini Coefficient 34.3 slowed compared to Q1-2015 despite con- and were affected by stronger external tinuing deflation, rising incomes and a c Life Expectancy at birth, years 74.3 demand for electrical machines, copper, Sources: World Bank, WDI, and M acro Poverty Outlook. decline in unemployment. and grain, higher prices of metals and the Notes: (a) M ost recent value (2012) Unemployment fell by 2.1 percentage depreciating Lev. Import growth was (b) Gini data show most recent WDI value (2011) (c) Life Expectancy data show most recent WDI value (2013) points in a year and reached 9.4 percent in more subdued (5.4 percent), based on July 2015, supported by growing employ- higher demand for raw materials and ment and active labor market policies. investment. Net capital inflows increased Employment picked up mostly in the as a result of the government debt issue fastest growing sector, ICT, and started to and higher capital inflows from the EU Recent positive developments are likely to recover in industry and construction, the while FDI inflows increased slightly to 1.9 help accelerate Bulgaria’s convergence to sectors that were hit hardest by the global percent of annual GDP. EU average living standards and reduce financial crisis. These sectors, together Banks reduced their exposure to foreign with real estate, contributed the most to capital, including to Greece, in the first poverty. Economic growth in 2015 is like- GDP growth. Employment growth, how- half of 2015. As a result, gross external ly to be higher than initially expected, ever, slowed in Q2 compared to Q1-2015 debt declined to 89.3 percent of GDP in supported by strong exports, especially in as a result of weakening of activity in June 2015 from 94.7 percent in the end of agriculture and tourism. 2014. the first half of 2015, and recovery of in- With employment picking up, poverty fell Though the Bulgarian banking sector had vestment. Declining unemployment, slightly to 15.2 percent in 2014 at the $5 a high exposure to Greece, it has weathered growing employment in industry and day poverty line, but remains substantial- the Greek crisis well. The measures that ly higher than the pre-crisis level of 13.0 the Bulgarian National Bank took prior to construction, and rising incomes have percent, as employment remains well the crisis in Greece helped ensure finan- contributed to reducing poverty. Political below pre-crisis levels—particularly in cial and operational independence of Bul- stability and the reinvigoration of reforms low-skilled jobs. garian banks and thus mitigated the nega- Deflationary pressures, driven by falling tive effects from the introduction of the are likely to continue strengthening the international oil prices, continued to affect bank holiday in Greece in July. fiscal position in the medium term. the harmonized index of consumer prices, After a widening of the fiscal deficit in FIGURE 1 Bulgaria /Contributions to annual growth, per- FIGURE 2 Bulgaria / Actual and projected poverty rates and centage points real GDP per capita, 2000-2017 35 18,000 20 15 30 16,000 10 14,000 5 25 12,000 0 Poverty Rate (%) GDP per capita 20 10,000 -5 -10 15 8,000 -15 6,000 -20 10 4,000 -25 5 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2,000 Consumption Gross fixed capital formation 0 - Changes in inventories Net Exports 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 GDP $2.5/day PPP $5/day PPP GDP per capita Source: NSI and World Bank staff estimates. Source: World Bank (see notes to Table 2). MPO 48 Oct 15 56  ●   World Bank ECA Economic Update October 2015 2014, fiscal policy tightened in 2015. Fiscal vestment. The economic recovery is pro- mand in China. In 2016 and 2017 the cur- accounts were in surplus until July 2015 jected to be modest, with growth improv- rent account is expected to turn into deficit as revenue increased by 13 percent year- ing to only 2.2 percent in 2016 and 2.7 as import growth accelerates. on-year in response to improvements in percent in 2017. The rebound of domestic The government is on track with carrying tax compliance and increased inflows of demand is expected to support growth in its plan for significant fiscal consolidation EU funds. Buoyant revenue supported the medium term while the contribution in 2015 and in the medium-term. The the substantial fiscal consolidation of net exports is likely to turn negative. cash fiscal deficit is expected to be re- planned in 2015 and is expected to miti- Poverty is expected to decline only mar- duced to 2.9 percent of GDP in 2015 and gate the slow progress in tightening of ginally to 14.8 percent in 2015 and 14.1 to narrow by about 0.5 percentage points expenditure in some sectors. In March percent in 2016. Increased child benefits of GDP per year in 2016 and 2017. 2015 the Government issued Eurobonds and heating subsidies for children and amounting to €3.1 billion to finance siza- elderly are expected to contribute to pov- ble debt repayments due in 2015. Govern- ment debt increased to 28.7 percent of erty reduction. Labor market develop- ments such as minimum wage increases Challenges GDP in June 2015 compared to 26.9 per- and the Youth Guarantee program for cent in the end of 2014. Nevertheless, activating young people not in education, The outlook is subject to downside risks Bulgaria still has one of the lowest gov- employment or training are expected to related to the strength of recovery in the ernment debt-to-GDP ratios in the EU. help reduce poverty as well. EU and pace of structural reforms domes- The external current account is expected to tically. Bulgaria’s adverse demographics continue to be in surplus in 2015, support- will continue be a challenge . Improving Outlook ed by strong external demand and positive terms of trade effects. Exports growth is growth, employment, and poverty out- comes will depend on expanding access to likely to decelerate in the second half of training and employment, especially for GDP is projected to grow by 1.9 percent 2015 due to the negative impact from the young people, Roma, and the low-skilled. in 2015, picking up speed compared to temporary capital controls in Greece dur- 2014 because of stronger exports and in- ing the summer and moderation of de- TABLE Bulgaria / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 0.5 1.1 1.7 1.9 2.2 2.7 Private Consumption 3.9 -2.3 2.0 0.7 2.6 3.4 Government Consumption -1.0 2.8 3.8 -0.5 1.2 1.4 Gross Fixed Capital Investment 1.9 -0.1 2.8 3.2 2.2 3.2 Exports, Goods and Services 0.7 9.2 2.3 6.0 3.8 4.5 Imports, Goods and Services 4.5 4.9 3.8 4.9 3.9 4.9 Real GDP growth, at constant factor prices -0.5 1.2 1.6 1.8 2.2 2.7 Agriculture -7.3 3.3 5.2 -0.1 1.5 1.5 Industry 1.6 -0.1 2.0 2.4 2.9 3.3 Services -0.8 1.6 1.2 1.7 1.9 2.5 Prices Inflation (GDP price deflator) 1.6 -0.8 0.6 1.2 1.3 1.6 Inflation (Consumer Price Index) 2.4 0.4 -1.6 -0.8 0.2 1.4 Current Account Balance (% of GDP) -0.3 1.9 0.9 0.7 -0.9 -1.4 Fiscal Balance (% of GDP) -0.5 -1.8 -3.7 -2.9 -2.5 -1.9 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 5.6 5.5 5.5 5.0 4.9 4.7 Poverty rate ($5/day 2005 PPP terms) 16.4 15.8 15.2 14.8 14.1 13.2 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 2-EU-SILC. (b) P ro jectio n using neutral distributio n (201 with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . 2)� (c) A ctual data: 201 2. P ro jectio ns are fro m 2013 to 2017. MPO 49 Oct 15 Macro Poverty Outlook Reports ●  57 below its pre-crisis level. It is estimated CROATIA Recent developments that the poverty rate, measured at $5/day PPP 2005, remained essentially unchanged in 2014 at 9.8 percent. Growth turned positive in late 2014 and The fiscal deficit reached 5.7 percent of grew further in the first half of 2015 (0.85 GDP in 2014 (ESA2010 methodology), percent y-o-y), supported by external de- averaging 6 percent over the last six years. 2014 mand and personal consumption. While The fiscal deficit reached 5 percent of 2015 Population, million 4.2 in 2014 GDP declined by 0.4 percent (to 13 GDP by March 2015 on the back of capital GDP, current US$ billion 57.1 percent below the pre-crisis GDP after six investment and interest payments’ rise GDP per capita, current US$ 13465 years of recession), in 2015, the economy and despite strong revenue performance. Poverty rate ($2.5/day 2005 PPP terms) a 2.1 is expected to grow by 0.9 percent. Con- Public debt more than doubled from 2008 Poverty rate ($5/day 2005 PPP terms) a 9.8 struction--showing signs of bottoming out to 85 percent of GDP by May 2015. In Gini Coefficient b 30.9 supported by a doubling of EU funds, March 2015, ahead of the April redemp- Life Expectancy at birth, years c 77.1 together with personal consumption and tion of a €1 billion bond, the government Sources: World Bank, WDI, and M acro Poverty Outlook. exports should lead the recovery. Business issued a 10-year €1.5 billion Eurobond Notes: optimism and consumer confidence im- with a yield of 3.3 percent or 260 basis (a) M ost recent value (2012) (b) Gini data show most recent value (2013) proved slightly in early 2015, the latter points above the mid-swap rate. In July, (c) Life Expectancy data show most recent value (2013) due to a reduction of personal income tax both S&P and Fitch reduced the country’s rates, freeze of the CHF/HRK exchange outlook to negative but kept the BB long- rate and the debt relief scheme imple- term rating. mented for social welfare beneficiaries. The current account remained in rough After twelve quarters of economic con- A 12-month decline in prices by 0.3 per- balance in 2014. The trade deficit nar- traction, Croatia returned to growth in cent in January-July 2015 – after a similar rowed to 14.8 percent of GDP reflecting drop in 2014-- also helped improve living growing exports to the EU and lower oil early 2015, supported by external demand standards. Unemployment remained high prices. Deleveraging by parent banks con- and personal consumption. There are ear- at about 17 percent in H1 2015 despite tinued, however. Inflows of FDI tripled ly signs of labor market recovery, from a strong active labor market policies and compared to a year earlier. The central low level, leaving the unemployment rate reduced labor shedding with slower cor- bank sold €500 million in early 2015 to high at about 17 percent. The fiscal deficit porate restructuring. Labor force participa- protect the kuna from further weakening. tion rose to 52.4 percent and the employ- remained high at 5.7 percent of GDP in ment rate (ages 15+) to 43.3 percent, while 2014, and fiscal consolidation is likely to soften even in 2015 as the country enters real wages grew by 3.5 percent year-on- year. Real pensions declined by 0.8 percent Outlook a pre-election period. To stem further year-on-year in April 2015 as inflow to early retirement increased in 2014, with Economic activity is expected to recover growth in public debt–which reached 85 adverse poverty impacts among house- gradually, with real GDP growth percent of GDP–fiscal adjustment needs holds dependent on pension income. strengthening from 0.9 percent in 2015 to to be supplemented with faster growth. Specifically, real per capita income re- 1.5 percent in 2017. Tourism and business mained flat in 2014 and over 8 percent services are expected to contribute to FIGURE 1 Croatia / Contributions to annual GDP growth FIGURE 2 Croatia / Actual and projected poverty rates and real GDP per capita, 2000-2017 Percent 12 25000 10 10 5 20000 8 Poverty Rate (%) GDP per capita 0 15000 6 -5 10000 4 -10 5000 2 -15 2007 2008 2009 2010 2011 2012 2013 2014 2015e 0 0 2015 2016 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2017 Final consumption Gross fixed capital formation Change in inventories Net exports Residual item GDP growth $2.5/day PPP $5/day PPP GDP per capita Sources: CROSTAT, World Bank. Sources: World Bank (see notes to Table 2). MPO 50 Oct 15 58  ●   World Bank ECA Economic Update October 2015 growth, with exports of pharmaceuticals, Spending Review, aiming to rationalize apparel, and car parts to Germany and Italy that are part of supply chains sup- costs of 187 state agencies (saving about HRK1 billion, or 0.3 percent of GDP a Challenges porting manufacturing growth. Vacancies year). In its 2015 Convergence Pro- in construction and manufacturing indus- gramme, the government planned to cor- The outlook is subject to downside risks. tries are suggesting this recovery is al- rect the excessive deficit by 2017, which is Due to its reliance on volatile capital flows ready underway. In addition, low infla- not in line with the 2016 deadline recom- and because of high public and private tion (projected at 0.2 percent), particularly mended by the European Council, which indebtedness, Croatia remains vulnerable in the energy and transport sectors, will would lead to public debt rising well to increased financial market volatility. A boost real incomes, including among the above 90 percent of GDP by 2017. Alt- missed EDP target, still weak consump- poor, who spend over 10 percent of their hough the European Council in June 2015 tion, slow corporate sector restructuring income on these items. decided not to activate the corrective ac- and EU funds absorption could further Private consumption is projected to grow tion against Croatia, it pointed out that the undermine investors’ perceptions and by 1.5 percent in 2015, supported by a "level of ambition remains below expecta- lead to further downward revision of Cro- debt relief scheme for the poorest, a gov- tions in a number of areas", and has given atia’s non-investment grade credit rating. ernment decision to fix the CHF-loan re- six new recommendations that the Croa- The government approved the draft legis- payment exchange rate to ease the debt tian Government should meet in 2015 and lation to convert all CHF-loans to EUR- burden, and the personal income tax cuts 2016. In this context and in the absence of loans leading to HRK8 billion in bank ahead of elections. Government consump- stronger private employment and wage losses. While this can help with reducing tion is projected to remain subdued due to growth, poverty is projected to decline the debt relief for households, potential the required fiscal consolidation under the only marginally, to 9.3 percent in 2015 and negative effects on international reserves, Excessive Deficit Procedure (EDP) with 9.0 percent in 2016. the kuna exchange rate, and financial sta- the EU. Nonetheless, the fiscal target un- The new stress test of the financial sector bility are yet to be assessed. Progress in der the EDP will likely be missed in 2015. suggests that a currency shock in the econ- addressing inactivity and unemployment The initial budget remained insufficiently omy will not cause a system-wide disrup- as the main causes of the recent rise in ambitious, targeting a deficit of 5 percent tion, but revealed weaknesses in eight poverty remains slow. Addressing fiscal of GDP. small- and medium-sized banks. vulnerability and existing social challeng- The fiscal deficit by March already NPLs slightly increased to 17.3 percent in es requires faster implementation of struc- reached 5 percent of GDP despite strong June 2015, threefold the pre-crisis low. tural reforms; however, this remains un- revenue growth thanks to the recovery of Corporate sector NPLs rose to 30.9 per- likely in an election year. private consumption and pre-season tour- cent, despite the pre-bankruptcy settle- ism. By July, the Government accepted ment schemes, while household NPLs only one set of recommendations from the increased to 12.1 percent. TABLE Croatia / Selected Economic and Social Indicators, Projections 2015- (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -2.2 -1.1 -0.4 0.9 1.2 1.5 Private Consumption -3.0 -1.8 -0.7 1.5 1.0 1.2 Government Consumption -1.0 0.3 -1.9 -1.1 -0.1 1.0 Gross Fixed Capital Investment -3.3 1.4 -3.6 1.3 3.8 4.0 Exports, Goods and Services -0.1 3.1 7.3 2.0 2.2 1.4 Imports, Goods and Services -3.0 3.1 4.3 2.1 2.6 2.0 Real GDP growth, at constant factor prices -3.2 -1.1 -0.1 0.9 1.2 1.5 Agriculture -14.7 -0.6 0.0 0.4 1.5 2.0 Industry -6.6 -2.8 0.5 2.3 2.5 2.7 Services -1.2 -0.6 -0.3 0.5 0.7 1.1 Prices Inflation (GDP price deflator) 1.6 0.8 0.0 1.1 2.3 2.7 Inflation (Consumer Price Index) 3.4 2.2 -0.2 0.2 1.5 2.0 Inflation (Private Consumption Deflator) 3.2 1.9 -0.4 0.4 2.6 3.5 Inflation (Consumer Price Index) 3.4 2.2 -0.2 0.2 1.5 2.0 Current Account Balance (% of GDP) -0.4 0.8 0.6 0.8 0.6 0.2 Fiscal Balance (% of GDP) -5.3 -5.4 -5.7 -5.0 -4.1 -3.4 Poverty Rate a,b,c Poverty rate ($2.5/day PPP terms) 2.1 2.1 2.1 2.1 1.7 1.6 Poverty rate ($5/day PPP terms) 9.4 9.7 9.8 9.3 9.0 8.7 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. In annual percent change unless indicated otherwise. Calculations based on 2009-EU-SILC Survey, 2012-EU-SILC survey, . Projection using Neutral Distribution (2012)�with pass-through = 0.87 based on GDP per capita constant PPP. a) Calculations based on 2012-EU-SILC survey. b) Projection using neutral distribution (2012) with pass-through = 0.87 based on GDP per capita constant PPP. c) b) Actual data: 2012. Data for 2012-14 are World Bank estimates, projections are from 2013 to 2017. MPO 51 Oct 15 Macro Poverty Outlook Reports ●  59 cuts in prices of health services and fuel CZECH Recent developments kept inflation low. The external current account was in sur- plus in the first seven months of the year REPUBLIC Growth accelerated to 4.4 percent year-on- year in Q2-2015, the highest growth rate (1.7 percent of annual GDP), exceeding by 0.5 percentage points of GDP the surplus since 2007, supported by strong domestic achieved in the same period a year earlier demand. Investment was the key growth due to gains in exports of services and driver and expanded by 8.4 percent on the transfers from the EU. Performance of 2014 account of faster absorption of EU funds. goods exports also improved on the basis Population, million 10.6 The importance of consumption increased of stronger external demand for machin- GDP, current US$ billion 205.3 significantly compared to 2014 as it was ery and equipment and weaker koruna. GDP per capita, current US$ 19400 boosted by improvements in labor market Machinery and equipment and gas sup- Gini Coefficient a 26.4 outcomes, low inflation, easing credit con- ported higher imports while low oil prices Life Expectancy at birth, years b 78.1 ditions, and expansionary fiscal policy. reduced the value of imported petroleum Sources: World Bank, WDI, and M acro Poverty Outlook. Exports grew at robust rate but was out- and petroleum products. Notes: (a) Gini data show most recent WDI value (2011) paced by imports as demand for invest- The fiscal deficit in 2015, of 1.9 percent of (b) Life Expectancy data show most recent WDI value (2013) ment goods increased. GDP, is expected to remain broadly un- Growth was associated with continuing changed compared to 2014. Better than improvements in the labor market. Gains expected economic growth and increased in employment were concentrated in man- excise on tobacco products are likely to The Czech economy gathered speed in ufacturing, trade, transport, and tourism, offset the negative effects from the intro- and information and communication, sec- duction of a reduced VAT rate on books, 2015 with GDP growing at 4.4 per- tors that contributed most to GDP growth medicines, and child nutritional products. cent in Q2-2015, the highest rate over in Q2-2015. Unemployment is one of the Spending pressures relate to higher index- the last seven years. Growth was sup- lowest in the EU and declined to 5.1 per- ation of pensions and rising wage bill as cent in July 2015 from 5.9 percent a year well as exceptionally high capital spend- ported by strong domestic demand as earlier. The Czech Republic also has the ing due to one-off transaction related to labor market conditions eased and EU lowest share of people living at risk of purchase of an aircraft and faster imple- -funded investment increased. Do- poverty and social exclusion in the EU— mentation of EU-funded projects as the 14.6 percent in 2013 compared to 24.5 per- deadline for disbursements ends in De- mestic demand should continue to cent in the EU and 30 percent in the EU cember this year. fuel growth in the medium term alt- New Member States. The banking sector remains liquid, well Consumer price inflation in the first seven capitalized and non-performing loans are hough growth is expected to decelerate months of 2015 of 0.4 percent on an annu- declining. Lending to non -financial corpo- in 2016 compared to 2015 as the one- al basis was broadly unchanged compared rations and households gathered speed in off factors boosting investment will to a year ago. The increase in excise duty the first half of 2015 in line with better of tobacco and higher gas prices exerted economic prospects and easing of lending not be in place. upward pressures on inflation while intro- conditions. Non-financial corporations duction of a second reduced VAT rate and increased significantly their deposits with FIGURE 1 Czech Republic / Contributions to annual growth, FIGURE 2 Czech Republic / Percent of people at risk of percentage points poverty or social exclusion, percent Percentage points 30 8 6 25 4 20 2 Percent 0 15 -2 10 -4 EU Czech Republic -6 5 -8 2007 2008 2009 2010 2011 2012 2013 2014 2015f 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Net exports Gross domestic investment Consumption GDP Sources: Eurostat and World Bank staff estimates. Source: Eurostat. MPO 52 Oct 15 60  ●   World Bank ECA Economic Update October 2015 banks while growth in household deposits should underpin robust household con- The fiscal consolidation plans rely on was more moderate compared to 2014. sumption in 2016 and 2017. Exports are better revenue collection as a result of likely to be boosted by continuing eco- continuous increase in excise rate on to- nomic recovery in the EU but the contri- bacco products and measures to boost tax Outlook bution of net exports on growth is likely to be neutral. compliance as well as on some savings in spending. Investment spending is ex- Consumer price inflation (CPI) is likely to pected to decline sharply as the effects The outlook for the Czech economy con- be contained by low fuel prices with CPI from one-off factors dissipate. tinues to improve. GDP growth is project- growing in 2015 by 0.4 percent, un- ed to accelerate to 4 percent in 2015 but changed from 2014. Price developments in slow down to 2.8 percent in 2016 and 2017 as effects from one-of factors at paly in the medium term are likely to be driven by demand pressures, further increase in Challenges 2015 wane. Economic recovery in 2015 is excises on tobacco and rising fuel prices. projected to be led by robust domestic External current account surplus is likely The outlook is subject to downside risks demand boosted by government invest- to increase in 2015 to 1.3 percent of GDP coming from the external environment. ment and policies to boost consumption. and then gradually decline to 0.6 percent Risks are related mainly to the strength With the expected slow start of implemen- by 2017. This decline will be driven main- and sustainability of recovery in the EU. tation of investment projects under the ly because of widening deficit of primary Renewed momentum to structural re- new financing period for EU funds, gov- incomes and moderation of net services. forms associated with improvements in ernment investment is likely to slow The trade surplus is expected to continue business environment, investments in down in 2016 and 2017 with improve- to improve as recovery strengthens in human capital and research and develop- ments in investment expected to be driven main trade partners. ment could mitigate to some extent nega- mainly by private sector. Planned further Government deficit is expected to decline tive impacts from external environment. increases in wage bill and low inflation gradually to 0.8 percent of GDP by 2017. TABLE Czech Republic / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015f 2016f 2017f Real GDP, at constant market prices -0.9 -0.5 2.0 4.0 2.5 2.9 Private Consumption -1.4 0.7 1.5 3.1 2.9 3.0 Government Consumption -1.8 2.4 1.8 2.1 2.0 1.8 Gross Fixed Capital Investment -3.2 -2.7 2.0 7.5 3.0 3.5 Change in Inventories, % contrib -0.2 -0.4 0.4 0.0 0.0 0.0 Exports, Goods and Services 4.3 0.0 8.9 7.9 7.0 6.7 Imports, Goods and Services 2.7 0.1 9.8 8.6 7.5 7.0 Real GDP, at constant factor prices -0.9 -1.3 2.6 4.0 2.5 2.9 Agriculture 9.4 3.4 2.9 1.2 1.1 1.2 Industry 0.0 0.0 1.3 3.4 1.7 2.0 Services 0.0 1.0 2.0 3.0 4.0 5.0 Inflation (Consumer Price Index) 3.3 1.4 0.4 0.4 1.4 1.8 Current Account Balance,% of GDP -1.6 -0.5 0.6 1.3 0.8 0.6 Fiscal Balance, % of GDP -3.9 -1.2 -2.0 -1.9 -1.2 -0.8 Sources: CSO, CNB, Eurostat, and World Bank Note: f = forecast. MPO 53 Oct 15 Macro Poverty Outlook Reports ●  61 tion (over 65 percent), the financial sector GEORGIA Recent developments still appears relatively stable. The average capital-adequacy ratio remains above 16 percent, the share of nonperforming loans Georgia’s economy slowed during the first is low at around 3 percent, and the overall half of 2015 as external conditions re- liquidity ratio is high at close to 40 per- 2014 mained bleak. Low growth during the cent. A rescheduling of dollar- Population, million 4.5 first quarter reflected the weak perfor- denominated loans to extend maturities, GDP, current US$ billion 16.2 mance of manufacturing and wholesale strict banking supervision, proactive man- GDP per capita, current US$ 3551 trade, while residential construction, pipe- agement of dollarization and informal Poverty rate ($2.5/day 2005 PPP terms) a 32.3 line transportation, financial intermedia- savings practices have helped so far. Poverty rate ($5/day 2005 PPP terms) a 69.4 tion and the agricultural sector all made However, in the medium-term, some dete- Gini Coefficient b 41.4 positive contributions. rioration is likely. Life Expectancy at birth, years c 73.9 Exports decreased by 24 percent year-on- The depreciation of the lari pushed the Sources: World Bank, WDI, and M acro Poverty Outlook. year (y/y) during the first half of 2015, inflation rate to 5.4 percent in August 2015 Notes: (a) M ost recent value (2014) while imports, which are 4 times higher (y/y), above the target rate of 5 percent. As (b) Gini data show most recent WDI value (2012) than exports, fell by 9 percent. Remittances a result, the central bank gradually raised (c) Life Expectancy data show most recent WDI value (2013) also fell sharply as labor market conditions the policy rate from 4 percent in January in Russia and other European destinations 2015 to 6 percent in August. for Georgian migrants continued to wors- Improved tax administration coupled en. International tourist arrivals, however, with the depreciation of the lari boosted Georgia’s economic growth moderated in have so far remained stable despite region- import-related VAT collections, generat- al turbulence. The current-account deficit ing an 11.9 percent increase in tax reve- the first half of 2015 to 2.6 percent, year - widened from 9.7 percent of GDP in 2014 nues in the first half of 2015 (y/y). Expend- on-year, as the external environment to 14 percent in the first quarter of 2015. itures were in line with the budget result- worsened resulting in weak export de- Foreign direct investment (FDI) financed ing in a fiscal deficit of 0.8 percent of GDP. mand, a slower-than-expected adjustment 25 percent of the external deficit, and pri- However, due to slowing growth, total vate external debt financed 30 percent. The revenue collection during 2015 is likely to in imports and declining remittances. For rest was covered by short-term financial be much lower than originally budgeted. 2015 as a whole, growth is likely at 2 per- flows, primarily, reserve losses of commer- Following a downward revision of the cent, driven primarily by investment and cial banks. The central bank has main- budget in July 2015 the annual fiscal defi- supported by a modest increase in con- tained gross international reserves at cit is projected at 3 percent of GDP. sumption. The fiscal deficit is projected at US$2.5 billion as of end-June (equivalent to Unemployment fell to 12.4 percent in 3.5 months of imports). With limited cen- 2014, though urban and youth unemploy- 3 percent of GDP due to improved reve- tral bank intervention, the economy large- ment remain persistently high at 22 and 31 nue collection in the first half of 2015 and ly adjusted to the external shock through percent, respectively. Poverty continued a downward revision in the budget. Pov- the depreciation of the lari. to decline through 2014, as the US$2.5/day erty rates continued to decline in 2014. Despite a 22 percent nominal depreciation and US$5/day poverty rates fell to 32.3 of the lari to the US dollar during January and 69.4 percent, respectively. Nonagri- to August 2015 and high rates of dollariza- cultural labor income and social transfers FIGURE 1 Georgia / GDP Growth Composition (%) FIGURE 2 Georgia / Actual and projected poverty rates and real GDP per capita, 2000-2017 9.0% 7.6% 7.2% 100 9000 5.2% 5.6% 6.0% 90 8000 3.2% 2.4% 80 7000 3.0% 1.6% 1.4% 1.8% 70 6000 Poverty Rate (%) GDP per capita 0.0% 60 5000 -3.0% 50 4000 40 -6.0% 3000 30 -9.0% 20 2000 10 1000 -12.0% I 13 II 13 III 13 IV 13 I 14* II 14* III 14* IV 14* I 15* 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Final consumption Gross fixed capital formation change in inventories Net export GNFS Statistical discrepancy GDP $2.5/day PPP $5/day PPP GDP per capita Sources: GeoStat. Sources: World Bank (see notes to Table 2). MPO 56 Oct 15 62  ●   World Bank ECA Economic Update October 2015 were the main drivers of poverty reduc- current expenditures or significant effi- External debt reached 103 percent of GDP tion during 2010-2013, with the former ciency improvements in public investment at end-March 2015, making debt sustaina- playing a larger role in urban areas while management. The fiscal deficit is expected bility a source of concern. Meanwhile, employment creation has so far played a to narrow to 2.6 percent of GDP by 2017. financial dollarization has exacerbated secondary role. During 2015, food -price Lower GDP growth rates are likely to Georgia’s vulnerability to exchange-rate inflation and falling remittances are ex- slow the pace of poverty reduction. The shocks. In this context, maintaining macro pected to negatively impact poverty. De- poverty rate at US$2.5/day is expected to -financial stability will require a combina- spite the overall decline in poverty rates, reach 31.6 percent in 2015 and 28.3 percent tion of fiscal discipline, monetary vigi- large urban-rural disparities persist, and in 2017. Limited fiscal space will pre- lance and a sustained commitment to the rural poverty rate is roughly double clude further increases in social spending, structural reforms. the urban rate. though a potential rise in pension pay- The government’s focus on social spend- ments and efficiency improvements in the ing is helping to reduce poverty and build Targeted Social Assistance program could human capital, but it is also increasing Outlook modestly accelerate poverty reduction. However, subdued agricultural growth expenditure rigidity. Prudent fiscal man- agement will be essential to manage ag- could present a serious obstacle to poverty gregate demand and maintain fiscal sus- A gradual economic recovery is expected reduction in rural areas. Further changes tainability. Finally, reforms to further en- to begin in 2016 with some pick-up in in consumer price inflation and remittanc- hance the business climate would support growth in Georgia’s main trading part- es are expected to be small as conditions economic growth, strengthen the fiscal ners. Growth is expected to recover from 2 in the region gradually improve. performance and accelerate job creation. percent in 2015 to 3 percent in 2016 and reach 4.5 percent in 2017. However, down- side risks to growth remain. No major fiscal policy shifts are anticipat- Challenges ed over the medium term, and the fiscal deficit is projected to remain at around 3 Georgia faces three main challenges over percent of GDP. Slower-than-expected the medium term: mitigating external growth could depress revenues, potential- vulnerabilities, managing fiscal pressures, ly requiring a further consolidation of and reducing unemployment. TABLE Georgia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 6.4 3.3 4.8 2.0 3.0 4.5 Private Consumption 3.5 -2.6 2.9 2.9 2.1 1.6 Government Consumption 3.3 -2.7 4.7 5.6 5.2 4.5 Gross Fixed Capital Investment 18.2 3.5 25.6 5.1 2.4 6.7 Exports, Goods and Services 11.8 21.0 -0.1 6.8 3.2 4.3 Imports, Goods and Services 12.0 3.0 9.8 5.7 -0.8 2.2 Real GDP growth, at constant factor prices 5.9 4.3 4.6 2.0 2.5 5.1 Agriculture -3.7 11.3 1.5 2.9 2.8 2.0 Industry 9.5 2.3 5.0 1.5 3.8 5.0 Services 6.8 3.6 5.3 2.0 1.8 6.0 Prices Inflation (GDP price deflator) 1.2 -0.7 1.2 7.6 6.1 6.0 Inflation (Consumer Price Index) -0.9 -0.5 3.1 5.0 6.0 6.0 Current Account Balance (% of GDP) -11.7 -5.7 -9.7 -11.0 -9.5 -8.5 Fiscal Balance (% of GDP) -3.0 -2.6 -3.0 -3.0 -2.9 -2.6 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 42.5 36.0 32.3 31.6 30.1 28.3 Poverty rate ($5/day 2005 PPP terms) 77.9 73.3 69.4 68.6 67.5 65.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 2 and 2014-HIS. (b) P ro jectio n using neutral distributio n (201 4)�with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 2, 2013, 2014. P ro jectio ns are fro m 2015 to 2017. MPO 57 Oct 15 Macro Poverty Outlook Reports ●  63 driven by the private sector (up 4.8 per- HUNGARY Recent developments cent yoy). Since 2012 the government has been pur- suing fiscal consolidation with the aim of Economic growth has been strong so far in bringing down the level of public debt. 2015, supported by exports and domestic For 2015 the government targets a fiscal 2014 demand. Growth however decelerated deficit of 2.4 percent of GDP, down from from 3.5 percent in the first quarter, main- 2.6 percent in 2014, to be achieved through Population, million 9.9 ly due to a poor performance by agricul- higher revenues and expenditure contain- GDP, current US$ billion 137.1 ture. On the production side, industry ment. The consolidated budget deficit GDP per capita, current US$ 13856 (up 6.1 percent yoy), and in particular widened slightly in H1 of 2015, in spite of Gini Coefficient a 28.9 manufacturing (up 7.0 percent), and con- a tax revenue increases (up 5.0 percent Life Expectancy at birth, years b 75.1 struction (up 6.5 percent yoy) were the yoy), due to the withholding of some pay- Sources: World Bank, WDI, and M acro Poverty Outlook. drivers, while agriculture contracted by ments for EU-funded projects following a Notes: 16.8 percent yoy due to unfavorable dispute over local tendering processes. (a) Gini data show most recent WDI value (2011) (b) Life Expectancy data show most recent WDI value (2013) weather conditions. On the expenditure CPI growth turned positive in May 2015, side, growth was led by household con- but it gradually declined subsequently sumption (up 3.0 percent yoy) and gross reaching 0.0 percent yoy in August. The fixed capital formation (up 5.2 percent drop in inflation was driven by low fuel yoy). Investment growth was driven pri- and food prices. The low inflation environ- Economic growth has been strong in marily by the construction sector. Public ment allowed the National Bank of Hunga- 2015, supported by exports, manufactur- investment went up by 15.3 percent yoy. ry (NBH) to further cut its benchmark in- ing and domestic demand. Private con- External trade remained a main contribu- terest rate by 15 bps in July, to 1.35 percent. tor to GDP expansion, but the growth Sovereign borrowing costs remain low, sumption remains on an upward path, as rates of exports (up 7.5 percent yoy) and with the 10-year bond yields reaching 3.46 disposable incomes of households improve. imports (up 6.5 percent yoy) slowed rela- percent in August and the 5-year CDS Investment shows mixed signals. Labor tive to the previous quarter. spreads at around 167 bps at end-August. market conditions have been improving. Economic growth helped improve the The government aims to reduce the high labor market conditions. The employment level of public debt (77 percent of GDP at Growth is expected to remain solid, as rate increased by 3.4 percent yoy during end-2014) through expenditure restrain. A domestic demand strengthens. Uncertain- May –July 2015 to 64.1 percent, while un- debt-relief and conversion program was ties in the external environment represent employment declined to 6.8 percent of the enforced in 2015 for households indebted a downside risk due to Hungary’s high labor force in June 2015 (down from 8 in foreign currency, which is estimated to level of public debt. Further reforms in the percent in June 2014). Noticeably, youth have cost the banking sector up to $3.5 unemployment has been on a steady de- billion, affecting its profitability and the business environment and the banking clining path, reaching 17.8 percent in the recovery of credit. Despite the improve- sector are needed to stimulate private sec- second quarter, (down from 25.7 percent, ments in economic activity and the mone- tor development. respectively 20.7 percent, in the same peri- tary easing stance of NBH, credit to non - od of 2013 and 2014). Gross monthly earn- financial corporations contracted by 3.4 ings expanded by 3.6 percent yoy in June percent yoy in the second quarter. FIGURE 1 Hungary / Contributions to annual GDP growth FIGURE 2 Hungary / Budget deficit and public debt, 2009-14 6 83 Deficit (% of GDP), inverted Debt (% of GDP) 5 81 scale 4 79 3 77 2 75 2009 2010 2011 2012 2013 2014 General government deficit (% of GDP) General government debt (% of GDP) Sources: World Bank. Sources: Eurostat. MPO 58 Oct 15 64  ●   World Bank ECA Economic Update October 2015 was one of the drivers of growth in 2014. Outlook Labor market conditions are expected to improve, driven by growth, accommoda- Challenges tive monetary conditions and lower house- The economy is expected to grow in 2015 hold indebtedness. The government plans Hungary’s economic growth prospects by around 3.0 percent. Growth in 2015 to narrow the fiscal deficit to 2.4 percent of remain good. Risks are associated primari- will be affected by the contraction of agri- GDP in 2015 and reduce public debt ly with the increase in the US policy inter- cultural production and the slowdown in through spending cuts, higher tax reve- est rates and the country’s high level of government spending. On the upside, the nues and higher reliance on borrowing public debt. The authorities aim to miti- external sector will remain a driver of from the domestic markets. We expect this gate this by increasing the share of the growth, in spite of the slowdown in ex- policy to continue to be pursued in 2016, Forint-denominated debt and by maintain- ports and imports growth. We forecast a although the reduction in the bank tax will ing a comfortable level of foreign exchange growth rate of around 3 percent for 2016, affect revenues. On the other hand, the reserves. On the downside, economic un- as the EU economy further strengthens further strengthening of the domestic de- certainties in the region, and a protracted and the disposable incomes of households mand should bring in additional revenues, recovery in the Eurozone could hamper grow, including due to the implementa- as observed in the first half of 2015. market confidence and adversely affect tion of the debt relief scheme and the in- Inflation is expected to gradually move Hungary’s growth prospects and financing creases in real wages and employment. higher in the rest of 2015 and in 2016, as costs. Given the high level of integration of Private investment growth will depend on the effects of the low energy prices dissi- its trade with the Eurozone, Hungary is the improvement of credit conditions for pate and as domestic demand gains mo- susceptible to adverse shocks. Cognizant the corporate sector. mentum. An increase in the food prices is of these risks, the government is com- The intention of the authorities to improve expected due to the poor agricultural pro- mitted to continuing to pursue a cautious the regulatory environment for the bank- duction and seasonal patterns. fiscal policy. The planned reduction in the ing sector and to reduce the banking tax The NBH may keep the loose monetary banking tax in 2016 may however affect starting with 2016 should boost business conditions for an extended period, due to the deficit target. For the medium term, confidence. The ability of the authorities to the low inflation environment, the stable Hungary should focus on boosting the rapidly mobilize the EU funds available growth conditions and the ongoing quan- economic growth potential by encouraging for the period 2014-2020 will positively titative easing of the ECB, which limit the the development of the private sector. impact upon the public investment, which scope of a rate hike in the near future. TABLE Hungary / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -1.5 1.5 3.6 3.0 3.1 3.2 Private Consumption -1.9 -0.1 1.6 2.9 3.0 3.0 Government Consumption -1.3 3.3 2.5 0.2 0.5 0.6 Gross Fixed Capital Investment -4.2 5.2 11.7 2.1 3.8 4.6 Exports, Goods and Services -1.5 5.9 8.7 7.6 6.8 6.5 Imports, Goods and Services -3.3 5.9 10.0 7.1 6.8 6.6 Real GDP growth, at constant factor prices -1.5 1.5 3.5 2.9 3.3 3.2 Agriculture -22.6 15.1 12.5 -4.0 5.1 1.0 Industry -1.8 -2.2 6.5 5.1 4.8 4.6 Services -0.1 2.5 1.8 2.3 2.5 2.6 Prices Inflation (GDP price deflator) 3.4 3.0 3.1 -0.3 2.1 2.3 Inflation (Consumer Price Index) 5.7 1.7 -0.2 0.2 2.4 2.5 Current Account Balance (% of GDP) 1.8 4.2 3.3 4.7 2.6 2.2 Fiscal Balance (% of GDP) -2.3 -2.4 -2.9 -2.5 -2.5 -2.5 Sources: Wo rld B ank, M acro eco nomics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 59 Oct 15 Macro Poverty Outlook Reports ●  65 drop in oil revenue prompted the govern- KAZAKHSTAN Recent developments ment to cut spending from 22.2 percent of GDP in 2014 to a projected 21.7 percent in 2015. President Nazarbayev announced a Real GDP growth slowed further in the 10 percent increase in the wages of health first half of 2015. Falling external and do- and education workers and a 25 percent 2014 mestic demand continued to be affected by increase in social benefits and scholarships Population, million 17.2 the fall in oil prices and weakening de- in an effort to partially compensate for the GDP, current US$ billion 217.4 mand in China and Russia negatively im- rise in inflation expected in the wake of GDP per capita, current US$ 12631 pacted the export sector. In response to the the depreciation. The government also Poverty rate ($2.5/day 2005 PPP terms) a 0.4 weak demand, industrial output growth plans to continue managing price increas- Poverty rate ($5/day 2005 PPP terms) a 15.3 stagnate at about 0.2 percent in the first 7 es for about 33 basic goods. b Gini Coefficient 28.6 months of 2015, similar to the same period Kazakhstan’s poverty rate (at US$5 per c Life Expectancy at birth, years 69.6 in 2014. Services sector growth fell from 5.7 day in 2005 PPP) fell from 54 percent in Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: percent in 2014 to an estimated 2.1 percent 2006 to 15.3 percent in 2013. This remarka- (a) M ost recent value (2013) in the same period. Inflation declined to an ble achievement was driven by strong (b) Gini data show most recent WDI value (2010) (c) Life Expectancy data show most recent WDI value (2013) estimated 3.9 percent y/y in July 2015, but economic growth, robust job creation and pass-through effects from the depreciation rising real wages. Despite the effects of the of the tenge are expected to boost inflation recent economic slowdown a combination in the second half of the year. of wage increases in the public sector, Global oil prices fell by about 50 percent increased social spending and price con- Kazakhstan’s GDP growth rate is ex- between June 2014 and June 2015, fueling trols is expected to leave poverty rates at pected to slow from 4.4 percent in 2014 speculative pressure on the tenge. The 13.3 percent in 2015, essentially un- to an estimated 1.5 percent in 2015 due central bank intervened aggressively to changed from 2014. While undertaking defend the exchange rate, providing injec- fiscal consolidation, the government is to low oil prices and weaker domestic tions of foreign exchange and tightening moving forward with two economic pro- and external demand. Both the fiscal tenge liquidity. As a result the credit sup- grams launched in 2014 designed to sup- ply contracted by 12 between June 2014 port selected segments of the economy. and external balances are projected to and June 2015. The first program is mostly used to ad- turn to deficits in 2015. Given current Faced with persistently low oil prices and dress weaknesses in the financial sector by growth projections it is unlikely that high external imbalances the central bank writing off nonperforming loans and sub- announced the adoption of a floating ex- sidizing credit to small and medium en- Kazakhstan will be able to sustain the change-rate regime on August 20, 2015, terprises. This program was complement- pace of poverty reduction. In this con- triggering a 25 percent depreciation of the ed by an additional injection of KTZ 250 tenge against the US dollar. billion into the banking sector and two text expanding social safety net systems The government has continued to imple- consumer-credit interventions to support and carefully targeting public invest- ment the fiscal consolidation program domestic demand. The second program, launched in early 2015 while protecting Nurly Zhol, is a public investment initia- ments could help. social expenditures to mitigate the pov- tive targeting the transportation and logis- erty impacts of the depreciation. The steep tics, industrial, energy, public utilities, FIGURE 1 Kazakhstan / Real GDP Growth Composition by FIGURE 2 Kazakhstan / Actual and projected poverty rates Expenditure and real GDP per capita, 2000-2017 Percent 90 25000 10 80 8 70 20000 6 60 Poverty Rate (%) GDP per capita 15000 4 50 2 40 10000 0 30 -2 20 5000 -4 10 2010 2011 2012 2013 2014 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Consumption Investment Net exports Statistical discrepancy GDP growth $2.5/day PPP $5/day PPP GDP per capita Sources: Statistical Office of Kazakhstan. Source: World Bank (see notes to Table 2). MPO 60 Oct 15 66  ●   World Bank ECA Economic Update October 2015 housing, and social infrastructure sectors. growth in industrial and services sectors continue to implement structural reform It will be implemented from 2015-2019. will impact on welfare, since wages and to enhance competitiveness. While ex- employment in the private sector have penditure consolidation will be important been the driving force behind recent pov- to the sustainability of the fiscal accounts, Outlook erty reduction. Poverty will not necessari- ly increase since the population in the oil social expenditures should continue to be protected. The planned expansion of the regions and workers in the private sector Orleu conditional cash program nation- Assuming that oil prices average about tend to be better off, but upward mobility wide in 2016 will enhance social protec- US$50 per barrel in 2015 and then gradu- will be limited and the pace of poverty tion. Kazakhstan continues to exhibit re- ally increase to US$58 per barrel by 2017, reduction will slow. Poverty rates are pro- gional disparities in economic outcomes GDP growth would be projected to gradu- jected to decline modestly from 13.3 per- and poverty reduction. The geographic ally recover from 1.5 percent in 2015 to 3.3 cent in 2015 to 11.8 percent in 2017. targeting of investments supported by percent by 2017. Weak internal and exter- Nurly Zhol can influence the extent to nal demand will constrain growth in the which they support poverty reduction and industrial and service sectors, and domes- tic demand will be negatively impacted by Challenges promote shared prosperity. Agricultural regions are both the most populous and the price and wealth effects of the depreci- poorest in the country. Moreover, rural ation. CPI inflation is expected to rise Oil prices will continue to have a major households are often the most vulnerable from 7.4 percent (y/y) in December 2014 to influence over Kazakhstan’s growth pro- to shocks, and agricultural regions experi- about 8.1 percent (y/y) in December 2015. spects, as well as its fiscal and external enced rising poverty rates during the Continued fiscal consolidation will im- balances and exchange-rate dynamics. global financial crisis in 2009 and a prove the overall fiscal balance from a Slowing growth and a worsening external drought in 2012. Accelerating poverty deficit of 2.9 percent of GDP in 2015 to a environment underscore the need to reduction and promoting shared prosperi- surplus of 1.8 percent in 2017. strengthen the sustainability of the coun- ty will require that special attention be Slowing growth will likely reduce the try’s macroeconomic framework, facilitate paid to the regional dimensions of devel- pace of poverty reduction. Dampened the adjustment to lower oil prices, and opment policies TABLE Kazakhstan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 5.0 6.0 4.4 1.5 2.1 3.3 Private Consumption 11.0 12.6 -2.0 -1.0 2.0 3.0 Government Consumption 13.2 1.7 10.3 -5.0 0.4 0.0 Gross Fixed Capital Investment 9.1 4.9 0.2 0.7 3.8 4.8 Exports, Goods and Services 4.7 -0.2 -4.6 -1.6 1.0 6.2 Imports, Goods and Services 20.9 5.2 -15.7 -5.0 2.5 3.0 Real GDP growth, at constant factor prices 5.4 5.6 4.0 1.7 2.1 3.3 Agriculture -17.4 11.2 1.3 2.7 2.5 3.3 Industry 1.9 3.1 1.8 0.9 1.4 3.3 Services 10.6 6.7 5.7 2.1 2.5 3.3 Prices Inflation (GDP price deflator) 4.8 9.7 6.0 -1.7 12.8 5.0 Inflation (Consumer Price Index) 5.2 5.8 6.7 5.3 9.5 5.3 Current Account Balance (% of GDP) 0.5 0.4 2.1 -1.2 -0.4 0.2 Fiscal Balance (% of GDP) 3.9 3.4 0.9 -2.9 0.5 1.8 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 0.8 0.4 0.4 0.4 0.3 0.3 Poverty rate ($5/day 2005 PPP terms) 21.7 15.3 13.5 13.3 12.8 11.8 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n 2009-HB S Survey, 201 3-HB S survey, . (b) P ro jectio n using average elasticity (2009-201 with pass-thro ugh = 1based o n GDP per capita co nstant P P P . 3) � (c) A ctual data: 201 2, 2013. P ro jectio ns are fro m 2014 to 2017. MPO 61 Oct 15 Macro Poverty Outlook Reports ●  67 7 percent in first half of 2015 compared to KOSOVO Recent developments same period last year, mainly due to im- proved tax collection. Expenditures in- creased by 5.8 percent, due to growth in The economy is showing signs of broad- subsidies and wages (19.5 percent and 10.7 based recovery in 2015, mainly due to domes- percent), counterbalanced by a 15.3 percent 2014 tic demand and stronger growth of exports decline in capital investments. Government than imports. The economy grew at 0.2 per- debt was low at 11.6 percent of GDP by Population, million 1.8 cent in Q1 2015, driven by 2.3 percent growth mid-2015, and with low interest rates, debt GDP, current US$ billion 7.2 in private consumption, a 1.5 percent growth service is at 3 percent of GDP. The financial GDP per capita, current US$ 3952 in government consumption, a 0.6 percent sector remains healthy, credit and deposit decline of investments and a zero net exports rates growing (7.1 percent and 0.3 percent) Life Expectancy at birth, years a 70.5 contribution. A pick-up of private consump- while NPLs falling from 8.8 percent (Q1 Sources: World Bank, WDI, and M acro Poverty Outlook tion growth and investments led to higher 2014) to 7.1 percent (July 2015) due to work Note: (a) Life Expectancy data show most recent value (2013) economic growth in Q2 2015. The Greek crisis of private enforcement agents. had no effect on any of the economic sectors Poverty decreased from 34.5 percent to in Kosovo due to lack of economic ties. 29.7 percent from 2009-2011 according to External imbalances widened the current national figures, and income growth of the account deficit in the first half of 2015. bottom 40 percent outpaced growth of the The economy is showing signs of broad- Prices remained stable with average defla- T60 group during 2006-2011, driven pri- tion of 0.5 percent during the first half marily by increases in earnings based recovery in 2015, mainly driven year 2015, which should boost real house- (comprising 50-60 percent of household by domestic demand. Growth is ex- hold incomes. incomes across all deciles and accounting However, increases in public wages are for the bulk of income growth during 2009 pected to accelerate to 3 percent in 2015 introducing distortions into the job market -2013); pensions and social assistance con- and 3.6 percent in 2016-2017, but it by increasing the premium on full -time tributed little to B40 income gains. While continues to provide limited opportuni- public sector jobs. Thus, economic growth aggregate employment was stable, there is is not underpinned by formal job creation. evidence of employment shifts to higher ties for formal employment. Incomes of LFS 2014 data reveal a 5 percentage point productivity sectors during the pre-crisis low-income households will be boosted increase in the overall unemployment rate period, especially among the B40 . and the youth unemployment rate during by accelerating agricultural growth and 2013-2014. The latter is especially high reduction in VAT rates for basic foods (over 61 percent). About 10.7 percent of the working age population were discour- Outlook and utilities, but delayed implementa- aged workers in 2014. Many Kosovars are tion of some social reforms (e.g. health reported to have migrated illegally to Economic growth is expected to reach 3 insurance) due to the fiscal rule will Western Europe during November 2014- percent in 2015, 3.5 percent in 2016 and 3.7 March 2015, driven by unemployment. percent in 2017, supported by larger FDI, have a dampening effect. The temporary fiscal deficit by June 2015 consumption and exports. In 2015 we was 1.3 percent of GDP. Revenues grew by assume no interruptions on energy pro- FIGURE 1 Kosovo / Contribution to annual GDP growth FIGURE 2 Kosovo / Growth incidence Curve (GIC), 2006-2011 Source: Statistics Agency of Kosovo and WB staff. Source: Statistics Agency of Kosovo and WB staff. MPO 62 Oct 15 68  ●   World Bank ECA Economic Update October 2015 duction (unlike explosion in Kosovo A CAD will remain unchanged at 8.2 per- power plant in 2014) and no large price deflation of consumption caused by public cent of GDP, because trade balance will grow by only 0.9 percent as export of ser- Challenges wage increase which lead to lower growth vices (travel expenses) grows faster in in 2014. Consumption is expected to grow second half-year. The outlook is subject to downside risks at 3 percent in 2015 and 4.4 percent in Poverty dynamics will be influenced by a such as weaker than planned execution of 2016, fueled by remittances and wages. combination of factors. First, growth in public investments and potential dissatis- Gross fixed capital formation will grow by the agricultural sector is forecast to accel- faction with lack of jobs. Preserving budg- 5.4 percent in 2015 and 5 percent in 2016. erate to 4.5 percent annually during 2015- et investments at significant levels amid Growth of public investment is expected 2017. Agro food processing and other fiscal consolidation will be a challenge. to recover in the second half of 2015 due manufacturing is expected to grow at Lack of energy security remains the larg- to fiscal stability boosted by new fiscal around 6.5 percent. This will benefit the est obstacle to attracting FDI, and con- consolidation program (new IMF SBA – in rural poor and B40; 60 percent of the poor straining private sector participation, com- July 2015), by cutting recurrent expendi- live in rural areas. Incomes of low income petitiveness, and having negative social ture and delaying some social reforms, households should also be boosted by the and health implications. Ensuring energy while maintaining larger investments. stable price level, and by the reduction of affordability for low income households Since out of pocket health expenditures the VAT rate to 8 percent for main food will also be a challenge, as achieving cost are high as a share of household budgets, commodities, and utilities. Second, pov- recovery may require very large increases particularly for low income households erty and income dynamics has been in consumer prices; which would require, (with an estimated poverty impact of strongly determined by labor earnings, in turn, substantial improvements to the about 2 percentage points of poverty and since the labor market situation is not social welfare infrastructure, primarily headcount), this will postpone the antici- forecast to improve in the immediate fu- increasing coverage of the poor. pated positive poverty effect of the intro- ture due to remaining structural barriers Addressing Kosovo’s macroeconomic duction of mandatory health insurance. like the inadequacy of the education sys- vulnerabilities, high unemployment and Excess liquidity in the banking sector will tem, low ECE rates among low income poverty requires significant and far reach- continue to provide macro-fiscal stability households, this will constrain future pov- ing structural reforms to boost economic by financing government domestic debt. erty reduction. growth and make it more inclusive. TABLE Kosovo / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 2.8 3.4 1.0 3.0 3.5 3.7 Private Consumption 2.7 2.0 1.3 2.4 3.6 3.6 Government Consumption 4.4 6.6 5.3 6.7 9.3 14.4 Gross Fixed Capital Investment -13.7 -0.2 1.8 6.3 5.5 1.2 Exports, Goods and Services 0.7 2.3 17.4 11.2 6.3 7.2 Imports, Goods and Services -7.6 -1.5 8.0 7.5 7.3 7.2 Real GDP growth, at constant factor prices 3.0 4.7 0.1 3.4 3.8 3.6 Agriculture -8.5 1.4 0.4 5.8 3.4 4.3 Industry 6.5 7.4 -3.5 10.2 5.7 5.3 Services 4.6 4.1 2.1 -0.9 2.7 2.5 Prices Inflation (GDP price deflator) 1.1 1.2 1.2 1.2 1.2 1.3 Inflation (Consumer Price Index) 2.5 1.8 0.4 -0.1 .. .. Current Account Balance (% of GDP) -7.5 -6.9 -8.1 -8.2 -8.0 -7.9 Fiscal Balance (% of GDP) -2.6 -2.9 -2.3 -2.6 -2.5 -3.0 Source: World Bank. Notes: f = forecast. In annual percent change unless indicated otherwise. MPO 63 Oct 15 Macro Poverty Outlook Reports ●  69 (5 percent in July versus 10.5 percent in KYRGYZ Recent developments December 2014), reflecting the combined impact of relative fiscal restraint, tight monetary policies and the slow growth of REPUBLIC A strong agricultural season and front- loaded gold production drove robust the money supply, as well as favorable terms-of-trade developments and lower growth during the first half of 2015. Eco- remittance inflows. Nevertheless, inflation nomic output outside the gold sector in- is still expected to average 9.4 percent in creased by 4.5 percent, year-on-year (y/y), 2015 due to the pass-through effect of the 2014 with growth in agriculture and services som’s depreciation. Population, million 5.7 offsetting a slowdown in the non-gold Poverty reduction in the Kyrgyz Republic GDP, current US$ billion 7.4 industrial and construction sectors. Do- has been uneven in recent years, and GDP per capita, current US$ 1301 mestic consumption and net exports changes in poverty rates tend to lag eco- Poverty rate ($2.5/day 2005 PPP terms) a 31.3 made positive contributions to growth. nomic growth. However, preliminary esti- Gini Coefficient b 27.4 However, total investment contracted as mates suggest that the share of the popu- Life Expectancy at birth, years c 70.0 the government slowed the implementa- lation living on less than US$2.5 per Sources: World Bank, WDI, and M acro Poverty Outlook. tion of the public investment program and day fell sharply from 30.2 percent in 2013 Notes: private construction growth declined. to 25.2 percent in 2014. Wage growth and (a) M ost recent value (2012) (b) Gini data show most recent WDI value (2012) Conservative fiscal policies, including a strong agricultural sales are driving pov- (c) Life Expectancy data show most recent WDI value (2013) deceleration in foreign-financed capital erty reduction. Pensions and social trans- investment coupled with efforts to contain fers have also supported increased con- current spending, yielded a fiscal surplus sumption among the poor, though these of 2.1 percent of GDP in the first half of programs are relatively small and limited Real GDP growth is projected to slow 2015, according to preliminary estimates. in scope. The decline in remittances is Frontloaded gold exports and a steep expected to increase the vulnerability of to 2 percent in 2015, reflecting an drop in both import volumes and prices households that include migrant work- adverse regional economic environ- significantly improved the trade balance ers, which are estimated to comprise during the first half of the year. However, about 15 percent of total households. ment and lower domestic gold produc- falling remittance inflows widened the tion. Growth is expected to recover current-account deficit, which—together gradually over the medium term, but with the depreciation of the Russian ruble and the Kazakhstani tenge—put down- Outlook significant downside risks remain. A ward pressure on the exchange rate. In the first eight months of the year the Kyrgyz- Despite a strong first semester economic modest growth outlook combined with stani som lost 10.5 percent of its value growth is expected to slow to an annual falling remittances and imported in- against the US dollar, prompting the cen- average of 2 percent in 2015. This forecast tral bank to sell US$179 million in an is based on the expectation (i) that gold flationary pressures may slow the effort to smooth the depreciation. output and prices will remain low during pace of poverty reduction. The annual inflation rate fell significantly the second half of the year, and (ii) that during the first seven months of the year weaknesses in the external environment FIGURE 1 Kyrgyz Republic / GDP Growth by Sector FIGURE 2 Kyrgyz Republic / Actual and projected poverty rates and real GDP growth, 2004-2017 Percentage Percent points Percent of population Percent 12 12 70 12 10 10 60 10 8 8 6 50 8 4 6 40 6 2 4 30 4 0 2 20 2 -2 -4 0 10 0 -6 -2 0 -2 2010 2011 2012 2013 2014 8m 2014 8m 2015 2004 2006 2008 2010 2012 2014 2016 Agriculture Construction Industry Trade GDP growth, RHS $2.5/day PPP, LHS Sources: Kyrgyz authorities and WB staff calculations using the Kyrgyz Republic Sources: World Bank (see notes to Table 2). Household Budget Survey. MPO 64 Oct 15 70  ●   World Bank ECA Economic Update October 2015 will continue to adversely affect both ex- non-gold economy). After an increase in ports and deepen regional integration will ports and domestic demand via trade and 2015, inflation is projected to decline in depend on its progress in improving trade remittances, respectively. The planned subsequent years. logistics and transport infrastructure, as acceleration of public investment in the Modest progress in poverty reduction and well as its efforts to harmonize domestic second half of the year is expected to par- shared prosperity is anticipated over the rules and regulations with EEU norms. tially mitigate these trends. However, the near term, though the weak connectivity While stronger economic growth should planned investment projects will be large- between gold output and economy-wide allow the government to continue to ex- ly foreign-funded and rely heavily on income levels and employment rates will pand public investment while rebuilding imported inputs, reducing their impact on blunt the impact of overall growth. The fiscal buffers, already high debt-to-GDP the domestic economy. poverty rate is projected to fall slightly ratios and new wage increase commit- Fiscal balances are projected to deteriorate from 25.2 percent in 2014 to 25 percent in ments made in 2015, limit the scope for in the second half of 2015, due a substan- 2015 and 24.3 percent in 2016, as modest further countercyclical spending if growth tial increase in both capital investment output growth, declining remittances and were to falter. and current spending on wages and pro- fiscal consolidation slow the growth of Further depreciation may require addi- curement. The fiscal deficit is expected to household income. tional efforts to reinforce financial sector reach 5.8 percent of GDP in 2015, up from resilience, particularly given the already 4.1 percent in 2014, generating a signifi- high levels of dollarization on bank bal- cant increase in the public debt stock. Fall- ing remittance inflows will widen the cur- Challenges ance sheets. The Kyrgyz Republic faces the risk of pov- rent-account deficit to an estimated 18.5 erty stagnating at a high level. Without percent of GDP, putting further pressure The key risks to the Kyrgyz Republic’s growth in domestic jobs and wages, mi- on the som. economic outlook are primarily external. gration opportunities or an expansion of Modest improvements in the external en- Developments in Russia and Kazakhstan, the safety net, sustained welfare improve- vironment and, more importantly, rising including movements in the ruble and ments are likely to be limited. In turn a gold production should help the Kyrgyz tenge, will directly affect the value of the challenge for the government will be to Republic return to a higher growth trajec- som and influence inflation dynamics. proceed with necessary fiscal consolida- tory. GDP is expected to increase by 4.2 The extent to which the Kyrgyz Republic tion while safeguarding those expendi- percent in 2016 and 3.4 percent in 2017 is able to leverage its accession to the Eur- tures that are most directly pro-poor. (and 3.7 percent and 4.2 percent for the asian Economic Union (EEU) to boost ex- TABLE Kyrgyz Republic / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -0.1 10.9 3.6 2.0 4.2 3.4 Private Consumption 11.2 8.0 5.3 0.5 3.0 2.4 Government Consumption 2.1 -0.4 -0.5 2.1 4.2 2.4 Gross Fixed Capital Investment 36.5 1.3 13.3 5.0 6.8 5.9 Exports, Goods and Services -19.2 12.3 -7.4 -5.5 8.8 8.5 Imports, Goods and Services 12.4 4.1 -2.6 -3.7 5.4 5.2 Real GDP growth, at constant factor prices -0.1 10.5 3.6 2.2 3.8 3.3 Agriculture 1.2 2.9 -0.6 3.0 2.5 2.9 Industry -11.7 28.0 -1.7 -5.1 7.5 0.7 Services 2.4 11.3 7.8 3.7 3.7 4.2 Prices Inflation (GDP price deflator) 8.7 3.2 7.9 7.7 9.6 6.9 Inflation (Consumer Price Index) 2.7 6.6 7.5 9.4 8.7 6.6 Current Account Balance (% of GDP) -15.6 -15.0 -16.8 -18.5 -16.9 -11.4 Fiscal Balance (% of GDP) -5.7 -3.9 -4.1 -5.8 -5.3 -3.7 Poverty Rate Poverty rate ($2.5/day PPP terms) 1/ 31.3 31.2 25.2 25.0 24.2 23.7 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. In annual percent change unless indicated otherwise. 1/ Calculations based on ECAPOV harmonization, using 2008-KIHS, 2011-KIHS, and 2012-KIHS. with pass-through = 1 based on GDP per capita constant PPP. Projection using Annualized elasticity (2008-2011) � Actual data: 2012. Data for 2013-4 are estimates, data from 2015 through 2017 are projections MPO 65 Oct 15 Macro Poverty Outlook Reports ●  71 In the first quarter of 2015, unemployment MACEDONIA Recent developments averaged 27.3 percent, down from 28.4 percent a year earlier. High frequency data points to further increase in job creation in FYR High frequency data suggests a moderate, but widespread slowdown in economic the second quarter. Youth unemployment has also declined to 48 percent (from 53 activity in 2015, possibly linked to political percent in 2014), but it is still among the turmoil. Industrial production growth highest in the region. Long-term unem- 2014 slowed down in the first half of 2015, as ployment remains a problem, reaching 46 Population, mn 2.1 growth moderated in a broad range of in- percent of unemployed individuals. GDP, US$, bn 11.3 dustries including apparel, mining, tobacco, Exports growth moderated slightly, while GDP per Capita, US$ 5370 non-metallic mineral and electrical equip- imports growth accelerated in the second GDP per Capita, US$ PPP 12096 ment. In contrast, construction , measured quarter of 2015. Still, the trade deficit nar- Poverty rate, US$5/day PPP1 35.0 by the value added of complete construc- rowed by 30 percent in the first half of Poverty rate, relative line2 24.2 tion work, remained robust in this period. 2015. While both accounts experienced Gini coefficient, income2 37.0 On the demand side, consumption and positive growth in Euros, they declined in Life expectancy 3 75.2 investment leading indicators provide US$ terms reflecting a depreciation of the School enrolment rate, primary 4 89.2 mixed signals. VAT revenues and imports Denar (which is pegged to the EUR) vis-à Sources: St at e St at ist ical of f ice, Cent ral Bank, WDI and St af f Calculat ions and domestic production of consumption -vis the US$. Private transfers were slight- Not es: goods have declined. However, retail ly lower than in 2014, but fully covered 1/ Dat a f or 2008 2/ Based on SILC dat a f or 201 3 trade increased by 2.1 percent (y-o-y) in the trade deficit, alleviating external fi- 3/ Dat a f or 201 4/ Dat a f or 201 3 2 real terms and household credit growth nancing pressures. Net FDI inflows de- averaged 12 percent (y-o-y) in the first half creased by 40 percent (y-o-y), largely driv- of 2015. Private consumption is expected en capital outflows registered in May 2015 to be fueled by increases in public wages, (the height of the political turmoil and the pensions and social benefits in the second Greek crises). half of 2015. Slow downs in capital spend- The government revised up the fiscal defi- ing and FDIs suggest moderation in gross cit projections for 2015. The government investment. Yet, investment loans to com- has recently introduced the 2015 supple- panies increased by 7.6 percent (y-o-y) in mentary budget, which increased expend- the first half of 2015 (compared to 4.4 per- itures and shifts its composition unfavora- cent increase for 2014). bly. Around 2/3 of public spending con- Deflation persisted in the first half of 2015. sists of public wages, social transfers and Prices briefly increased in the first half of subsidies, capital spending is low and 2015, but fell again by 0.4 percent (y-o-y) constantly under realized. While the gov- in July 2015, driven by energy prices. In ernment made efforts to decrease the Jan-Jul 2015 , average prices were 0.3 per- share of wages and unemployment bene- cent lower than in Jan-Jul 2014. fits in total spending, increases in pen- Unemployment continued to decline, sions, social benefits and subsidies have helped by job creation in a range of sectors . outweighed these efforts. In contrast, capi- FIGURE 1 Macedonia FYR / Contributions to Annual GDP FIGURE 2 Macedonia FYR / Actual and projected poverty Growth rates and real GDP per capita, 2000-2017 in percent Poverty GDP growth 15 28 8 National Poverty Rate 10 27 7 GDP Growth Rate 6 5 26 5 25 4 0 24 3 -5 2 23 1 -10 22 2007 2008 2009 2010 2011 2012 2013 2014 0 21 -1 Final consumption Gross capital formation 20 -2 Net exports Real growth 2010 2011 2012 2013 2014 2015 (f)2016 (f)2017 (f) Sources: FYR Macedonia State Statistics Office and World Bank staff calculations. Note: National poverty defined at 60% of median equivalised income. Sources: Poverty from Macedonia SSO. GDP growth from WDI and World Bank projections. MPO 70 Oct 15 72  ●   World Bank ECA Economic Update October 2015 tal expenditures have declined as a share crease in poverty rates, from 27.0 percent creation continues to take place. Increases of total spending in the past three years. in 2010 to 24.2 in 2013, despite a 6 percent in social benefits are also expected to con- The government has missed its initial fis- increase in the poverty line, signaling an tribute to this result in the near term, but cal targets every year since 2012, which improvement in living conditions at the with possible implications for fiscal sus- reflects weaknesses in public financial bottom of the distribution driven by con- tainability. As in recent years, the ex- management. siderable employment creation and con- pected average annual growth of 1 per- Although still lower than the regional aver- tinuous increases in pensions and agricul- cent in agriculture is unlikely to lead to age, FYR Macedonia’s public debt has in- tural subsidies in the recent years. significant employment creation or farm creased rapidly in recent years. Public debt income increases, making a considerable has almost doubled since 2008, reaching reduction in rural poverty unlikely in the 43.7 percent of GDP in the first quarter of 2015. The debt is expected to continue Outlook short term. increasing in 2015 as the government stepped-up its domestic borrowing to finance the re-payment of EUR 150 million Growth is expected to pick-up in 2016 and 2017, reaching 3.4 and 3.7, respectively, Challenges Eurobond and pre-finance part of the deficit under the assumption that there is no fur- level for 2016. The public debt is expect to ther escalation of the political turmoil. The country is facing some challenges in reach 50 percent of GDP in 2017, following Public investment, FDI related exports the coming period that include further the implementation of an ambitious policy and to a lesser extend manufacturing are repercussions from the political crisis, program put forward in 2014. expected to drive growth. Private con- sustainable and credible fiscal consolida- Poverty has declined in the recent years, sumption is expected to gradually pick-up tion; continued reduction in unemploy- following employment growth and in- as employment expands . ment, especially youth and long-term un- creases in government transfers. Although Poverty rates are expected to decline in employment. internationally comparable estimates of the medium-term. Strong growth in 2015- Limited access to the SILC and HBS mi- poverty are not available for FYR of Mace- 2017 is expected to contribute to further crodata limits the to track and benchmark donia, national estimates register a de- poverty reduction, as long as employment improvements in living conditions. TABLE Macedonia FYR/ Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -0.5 2.7 3.8 3.2 3.4 3.7 Private Consumption 1.2 2.1 2.3 1.9 2.2 2.4 Government Consumption 2.4 2.5 -1.2 0.7 1.0 1.0 Gross Fixed Capital Investment 10.2 -16.6 13.5 15.5 10.0 9.0 Exports, Goods and Services 2.0 -2.7 17.0 7.5 8.0 8.2 Imports, Goods and Services 8.2 -10.0 14.5 6.8 7.2 7.5 Real GDP growth, at constant factor prices -0.6 4.1 3.6 2.7 3.2 3.7 Agriculture -16.0 9.0 2.0 1.0 1.0 1.0 Industry -5.0 5.9 5.0 3.5 5.0 6.0 Services 3.8 2.8 3.2 2.6 2.8 3.1 Prices Inflation (GDP price deflator) 1.0 4.3 1.4 -5.8 1.1 1.1 Inflation (Consumer Price Index) 3.3 2.8 -0.1 0.4 1.4 2.0 Current Account Balance (% of GDP) -3.1 -1.8 -1.5 -2.8 -3.1 -3.0 Fiscal Balance (% of GDP) -3.9 -4.0 -4.2 -3.9 -3.5 -3.0 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 71 Oct 15 Macro Poverty Outlook Reports ●  73 2015 and foreign reserves decreased 8 MOLDOVA Recent developments percent, although still covering over 3 months of imports. The government faces increased fiscal Despite a slowdown of external demand pressures due to lower external assistance and remittances, the economy grew 3.6 and underperforming tax collections. In 2014 percent y/y in the first half of 2015. Depre- January-July 2015, the general government Population, million 3.5 ciation pressures stimulated net exports deficit was 0.8 percent of GDP, but the GDP, current US$ billion 8.0 contributing 3.9 percentage points (p.p.), government had to ration expenditures to GDP per capita, current US$ 2243 while the low level of remittances almost align them with available financing. Due Poverty rate ($2.5/day 2005 PPP terms) a 3.8 halted consumption growth. Small growth to higher borrowing costs, lower collec- Poverty rate ($5/day 2005 PPP terms) a 39.6 of fixed investments was fully compen- tions at customs and lower official external Gini Coefficient b 30.6 sated by a decline in stocks. assistance, the government restricted pro- Life Expectancy at birth, years c 68.7 Consumer price inflation has been on the curement of goods and services. Sources: World Bank, WDI, and M acro Poverty Outlook. rise and above the central bank target Higher inflation, lower remittances and a Notes: (a) M ost recent value (2013) range, so the National Bank of Moldova severe summer drought are likely already (b) Gini data show most recent WDI value (2011) has significantly tightened the policy affecting living standards in Moldova, (c) Life Expectancy data show most recent WDI value (2013) stance. Twelve-month inflation exceeded pushing poverty into an upward trend. the target range of 5±1.5 percent in March Poverty has been on the decline in recent and stood at 12.2 percent in August 2015. years, going from 46.4 percent in 2012 ($5/ Depreciation of the Leu resulted in higher day, 2005 PPP) to an estimated 36.6 percent import prices, and emergency loans to in 2014. However, recent developments are While Moldova’s economic performance three troubled banks increased liquidity in likely to have had a negative impact on the system. In response, the monetary household income. Farmers, particular was strong in early 2015, a recession is authority increased the base interest rate small ones, have been hard hit by the com- projected in the second half of the year due by 13 p.p. since the beginning of the year bination of Russian restrictions and a se- to the bad harvest and negative shocks to 19.5 percent and significantly tightened vere summer drought and, with most of from demand and remittances. Poverty the mandatory reserve requirement in the Moldovan poor residing in rural areas national currency. and employed in agriculture, this is ex- ($5/day) could increase by 1.2 p.p. to 37.8 Recessions in Ukraine and Russia and pected to have had a negative impact on percent in 2015. A modest recovery is domestic political instability worsened the rural poor and vulnerable. Moreover, expected in 2016 which will likely halt Moldova’s external position, while trade the combination of declining remittances further increases in poverty. However, reorientation towards the EU markets inflows, which account for 15-20 percent of risks from the external environment and continued. Exports to Russia halved and household income, and a slight increase in Romania became the largest export mar- the unemployment rate (going from 3.7 costs of the failed banks’ resolution could ket for Moldova. In July, money transfers percent in Q2 2014 to 4.1 percent in Q2 undermine macroeconomic stability and (a proxy for remittances) to Moldova 2015), have likely put additional down- affect living standards. dropped 30 percent, y/y. As a result, the ward pressure on household income. Final- Leu lost almost a quarter of its value ly, higher consumer inflation has started to against the dollar since the beginning of erode households’ purchasing power. FIGURE 1 Moldova / Real GDP growth and current account FIGURE 2 Moldova / Actual and projected poverty rates and balance real GDP per capita, 2000-2017 100 6,000 90 5,000 80 70 4,000 Poverty Rate (%) GDP per capita 60 50 3,000 40 2,000 30 20 1,000 10 0 - 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 $2.5/day PPP $5/day PPP GDP per capita Source: National authorities and World Bank team. Source: World Bank (see notes to Table 2). MPO 72 Oct 15 74  ●   World Bank ECA Economic Update October 2015 be accompanied by very modest declines the banking sector risk undermining the Outlook in poverty. The projected slow economic recovery of 0.5 percent will be constrained macroeconomic stability achieved in recent years. With higher projected public debt by still low remittances flows, subdued and lower levels of foreign reserves, Mol- Moldova’s economy is projected to shrink consumption, high credit costs and higher dova has limited macroeconomic buffers and poverty levels are expected to in- local energy tariffs. Net exports are pro- to sustain a more severe deterioration of crease in 2015. The economy is likely to jected to be the main growth driver given the economic activity. The recognition of sharply contract by 6 percent in the sec- the exchange rate adjustments and trade the losses in the banking sector could in- ond half of 2015 resulting in a 2 percent reorientation away from CIS countries. crease the public debt to 47 percent of GDP decline for the year due to hot weather The long overdue increase of utilities’ in 2015, from 32.5 percent a year earlier. It affecting crop output (with a double digit tariffs will keep inflation above the target is important for Moldova to maintain the decline), projected deep recessions of the range in 2015-2016. With a weaker econo- flexible exchange rate arrangement to eastern partners, and tighter monetary my, fiscal pressures will persist from high withstand adverse external shocks. policy. The 20 percent decrease in re- recurrent expenditures, recognition of Lower than expected growth of traditional mittances and weak domestic credit ex- fiscal cost of failed banks and lower exter- trading partners and failure to improve pansion will lead to the contraction of nal budget support. For households, de- domestic business environment could domestic demand. Moderate poverty rates spite some recovery in 2016, double-digit have a bigger negative impact on Moldo- ($5/day, 2005 PPP) will increase by 1.2 inflation– partly from increase in utility va with further poverty increases. These p.p., to 37.8 percent. The economic con- tariffs - and lower remittances are ex- poverty increases could materialize traction in the second half of the year, pected to limit any significant improve- through potentially higher unemploy- coupled with the reduction in remittances ments in living standards and poverty ment, higher utility tariffs and prices, and and higher inflation, will add to the nega- rates. Moderate poverty is likely to stand persistently low remittances inflows. Mov- tive effects on households. Increases in at 37.5 percent in 2016. ing forward, structural reforms supported public wages in late 2014 and indexation by development partners and investors of pensions in April 2015 are expected to are needed to maintain macro-fiscal stabil- partially mitigate incomes shocks for some groups, but less so for those in the Challenges ity, increase the competitiveness of the Moldovan economy and boost job creation bottom 40 percent of the distribution who for more sustainable market income rely relatively less on wage income. The unfavorable regional environment, sources for households. Moldova’s economy will slowly regain its monetary and fiscal costs of resolution of growth momentum in 2016, expected to the troubled banks and poor governance in TABLE Moldova / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -0.7 9.4 4.6 -2.0 0.5 4.0 Private Consumption 1.0 6.4 2.9 -1.8 0.6 3.7 Government Consumption 0.7 -0.1 0.2 -2.0 0.2 2.2 Gross Fixed Capital Investment 1.8 3.8 10.1 -7.3 -0.8 1.4 Exports, Goods and Services 1.7 9.6 1.1 -1.1 3.7 4.5 Imports, Goods and Services 2.2 4.4 0.4 -3.5 2.8 3.8 Real GDP growth, at constant factor prices -1.1 10.6 5.4 -2.0 0.4 4.0 Agriculture -20.1 46.6 8.2 -12.5 7.7 5.3 Industry 8.3 1.5 6.2 2.8 -1.1 4.0 Services 2.7 4.0 4.2 0.6 -1.5 3.5 Prices Inflation (GDP price deflator) 7.9 4.1 6.3 8.9 9.8 5.4 Inflation (Consumer Price Index) 4.6 4.6 5.1 9.5 11.9 5.0 Current Account Balance (% of GDP) -8.8 -6.6 -8.0 -8.0 -7.9 -6.6 Fiscal Balance (% of GDP) -2.1 -1.8 -1.8 -2.7 -3.0 -2.5 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 6.0 3.8 3.1 3.4 3.4 2.8 Poverty rate ($5/day 2005 PPP terms) 46.4 39.6 36.6 37.8 37.5 34.8 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 3-HB S. (b) P ro jectio n using neutral distributio n (201 3)�with pass-thro ugh = 0.87 based o n GDP per capita co nstant P P P . (c) A ctual data: 201 2, 2013. P ro jectio ns are fro m 2014 to 2017. MPO 73 Oct 15 Macro Poverty Outlook Reports ●  75 workers aged 50-64 as well as those living MONTENEGRO Recent developments in the poorer Northern region increased. Although fiscal consolidation efforts led to a reduction of the deficit to 1.4 percent of The economy grew by 1.5 percent in 2014, GDP in 2014, highway construction costs led by private consumption and invest- (about 23 percent of GDP) will burden 2014 ment that partially offset the negative public finances in 2015-2018, worsen debt Population, million 0.6 effects of the floods, delayed large invest- sustainability and increase financing risks. GDP, current US$ billion 4.6 ment projects and weaker than expected While the 2015 deficit is likely to amount GDP per capita, current US$ 7318 external demand. Real activity improved to about 6 percent of GDP, the govern- Poverty rate ($2.5/day PPP terms) a 2.8 in the beginning of 2015 with growth ment reform program aims to support the Poverty rate ($5/day PPP terms) a 18.7 strengthening to 3.2 percent year-on-year achievement of large non-highway fiscal Gini Coefficient b 32.2 in Q1. Tourism outcomes reinforced retail surplus. The proposal would be enacted Life Expectancy at birth, years c 74.8 trade, while construction output went up through additional revenue measures by 9.7 percent from a year earlier. (retaining the crisis PIT tax and increase in Sources: World Bank, WDI, M acro Poverty Outlook, and ECA TSD. Notes: Poverty was reduced with positive eco- the rate of health insurance contribution (a) M ost recent value (2013) (b) Gini data show most recent ECATSD value (2013) nomic growth since 2012, though with high by 0.5 percentage points) as well as a pen- (c) Life Expectancy data show most recent WDI value (2013) vulnerability to macro risks. Poverty, (at sion indexation freeze in 2015, and elimi- $5/day 2005 PPP), peaked at 19.2 percent in nation of retirement under more favorable 2012 and declined to an estimated 18.7 per- terms. Refinancing risk in 2015 was re- cent in 2014. While social transfers have duced by the ECB’s monetary easing that contributed to reducing poverty, the over- led to improved external financing condi- Economic activity accelerated in early all poverty trend closely mirrors labor mar- tions. The March 2015 Eurobond worth 2015 on the back of stronger growth in ket performance, particularly employment €500 million was issued at a rate of 3.87 private consumption and investment. growth in low-skill sectors. The unemploy- percent (half the rate from the 2010 issue). Poverty is expected to continue declining ment rate in the first half of 2015 amounted However, in H1 2015, public debt in- to 17.6 percent (a four-quarter average), creased to 70.8 percent of GDP (or 82.2 given economic growth and notable im- reaching its lowest level since 2008, and percent with guarantees included) which provements in activity and employment labor force participation and employment raises the risks of future refinancing. rates, now the highest since 2008. Howev- among the population 15 and above in- External imbalances deepened in early 2015. er, high unemployment, in particular of creased to 53.1 and 43.8 percent, respective- Declining net exports, dividend payments to ly. Higher rates of employment growth in equity holders abroad and a drop in work- youth and elderly, remains a challenge. sectors such as agriculture and administra- ers’ remittances widened the current ac- External and fiscal imbalances have start- tive and support service, together with count deficit (CAD) to 15.9 percent in H1 ed to worsen in 2015 because of highway- higher average real net wages in agricul- 2015, reversing a five-year positive trend. related imports and capital spending. The ture (2.3 percent) and construction (6.5 per- Because remittances are a relatively small fiscal deficit of 6 percent of GDP in 2015 cent) are likely to have translated into in- share of the incomes of poor households, come growth among poor households. the decline in remittances is expected to would worsen debt sustainability. The labor market recovery has been une- have only a moderate impact on their in- ven, however. The unemployment rate for comes. This high level of CAD was fi- FIGURE 1 Montenegro / Contributions to annual GDP FIGURE 2 Montenegro / Actual and projected poverty rates growth and real GDP per capita, 2000-2017 25 18,000 16,000 20 14,000 12,000 Poverty Rate (%) GDP per capita 15 10,000 8,000 10 6,000 4,000 5 2,000 0 - 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 $2.5/day PPP $5/day PPP GDP per capita Sources: MONSTAT, World Bank. Sources: World Bank (see notes to Table 2). MPO 74 Oct 15 76  ●   World Bank ECA Economic Update October 2015 nanced by robust net FDIs amounting to percent in 2016-2017, driven by public and 10 percent of GDP. However, debt- creating inflows remain high leading to a private sector investments into public infrastructure and tourism. Positive eco- Challenges further rise in external debt to GDP ratio nomic growth, through improved labor estimated at 121 percent. demand and continued employment ex- The outlook is subject to downside risks. After months of declining, lending growth pansion, is expected to lead to further A regional sovereign debt crisis and geo- turned positive in May on the back of poverty reduction. Lower energy and political tensions, while not having a di- stronger credit to households. Non - transport costs associated with falling oil rect impact on Montenegro, may affect performing loans rose to 16.4 percent of prices are expected to benefit poor house- the economy via second-round effects total loans by July 2015, from 15.9 percent holds, who spend a relatively high share (trade and capital flows from EU, as well in 2014. In parallel, the newly enacted of total expenditures on these items. as increased financial volatility). Law on Voluntary Financial Restructuring The fiscal deficit will be averaging 6 per- There are also risks on the fiscal side that of Debts to Financial Institutions will cent of GDP a year due to the planned include the maturity in 2016 of the 5-year hopefully lead to resolution of bad assets annual 9.5 percent of GDP in capital Eurobond equivalent to 10 percent of GDP to unlock access to capital to corporates. spending. Government consumption is and the exchange rate risk related to the In addition, in August 2015, the parlia- projected to decrease to create fiscal space dollar-denominated highway loan. While ment adopted the law on conversion of for a sharp rise in public investments in the highway project presents a growth CHF loans into EUR costing some EUR30 2015-18. Public debt will rise throughout opportunity, it is also the main downside million (0.8 percent of GDP) to be equally the medium term to peak in 2018 at 77 risk for economy. The authorities need to shared among the borrowers, the bank percent of GDP. This macro-fiscal frame- ensure fiscal discipline, strengthen the and the state. Domestic deposits growth work already led the credit rating agen- banking sector and undertake structural accelerated to 13.2 percent in July 2015. cies to downgrade Montenegro's sover- reforms to raise potential growth once the After persistent deflation throughout eign rating (to B+ with a stable outlook) highway construction ends. Household 2014, 12-month inflation turned positive which may increase the cost for the bonds welfare remains highly exposed to macro (1.5 percent) in the first seven months of redemption in 2016. Furthermore, the risks and the labor market is vulnerable to 2015 as demand picked up. external imbalance is likely to rise further volatile regional economic conditions. from the already high level due to the imports required for highway construc- Outlook tion. FDI is projected to remain stable (based on announced investments in in- frastructure, tourism, energy and agricul- Economic growth is expected to expand in ture projects) at around 9 percent of GDP, 2015 to 3.4 percent and remain at around 3 covering more than half of CAD. TABLE Montenegro / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -2.5 3.3 1.5 3.4 2.9 3.0 Private Consumption -3.2 1.1 1.3 1.2 2.5 2.2 Government Consumption 3.1 1.4 1.5 -3.1 -1.5 0.3 Gross Fixed Capital Investment -3.3 8.8 -3.0 29.3 -3.7 -3.4 Exports, Goods and Services -1.2 -1.3 -0.4 0.7 1.6 0.7 Imports, Goods and Services 0.9 -3.1 1.5 5.0 -1.8 -2.1 Real GDP growth, at constant factor prices -2.0 3.8 1.5 3.4 2.9 3.0 Agriculture -10.5 16.1 -22.3 3.2 3.3 2.1 Industry -9.5 4.3 4.5 5.8 4.7 3.5 Services 3.1 1.6 4.7 2.4 2.0 2.8 Prices Inflation (GDP price deflator) -0.1 2.2 1.4 1.0 2.7 1.6 Inflation (Consumer Price Index) 4.1 2.2 -0.7 0.0 .. .. Inflation (Private Consumption Deflator) 2.0 1.9 -0.9 4.2 2.0 1.3 Inflation (Consumer Price Index) 4.1 2.2 -0.7 1.0 1.9 2.0 Current Account Balance (% of GDP) -18.7 -14.6 -15.4 -16.0 -16.4 -16.8 Fiscal Balance (% of GDP) -5.9 -4.8 -1.4 -5.9 -5.5 -4.4 Poverty Rate Poverty rate ($2.5/day PPP terms) 2.4 2.8 2.8 2.7 2.7 2.7 Poverty rate ($5/day PPP terms) 19.2 19.1 18.7 17.3 16.3 15.3 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. In annual percent change unless indicated otherwise. Calculations based on ECAPOV harmonization, using 2013-HBS. with pass-through = 0.87 based on GDP per capita constant PPP. Projection using Neutral Distribution (2013)� (c) Data for 2012-13 are actual, 2014 is an estimate and 2015-17 are projections. MPO 75 Oct 15 Macro Poverty Outlook Reports ●  77 cent (year on year). Between mid-2014 and POLAND Recent developments mid-2015 average wages in the enterprise sector increased by 2.5 percent. In the same period, average pensions increased by 2.3 In the first half of 2015, the economy ex- percent in the general system. panded by 3.4 percent year on year, the Job creation and real increases in wages 2014 same rate as in 2014, up from 1.7 percent in and pensions are expected to have result- Population, million 38.0 2013. Domestic demand increased by 3 per- ed in further poverty reduction in 2014. GDP, current US$ billion 549.6 cent in the first half of the year and re- Poverty reduction was swift before the GDP per capita, current US$ 14457 mained the main growth driver, while the 2009 crisis, with the US $5-a-day 2005 PPP Poverty rate ($2.5/day 2005 PPP terms) a 0.9 contribution of net exports was slightly poverty rate declining from 18.7 percent Poverty rate ($5/day 2005 PPP terms) a 5.1 positive. Private consumption continued to in 2004 to 5.3 percent in 2009. However, Gini Coefficient b 33.1 benefit from higher real disposable incomes the slow recovery halted progress, with Life Expectancy at birth, years c 76.8 as a result of improved labor market condi- poverty remaining at slightly above 5 per- Sources: World Bank, WDI, and M acro Poverty Outlook. tions, relatively strong credit growth to cent through 2013. Supported by increases Notes: (a) M ost recent value (2012). households, and a boost from consumer in real incomes, poverty is estimated to (b) Gini data show most recent WDI value (2012). (c) Life Expectancy data show most recent WDI value (2013). price declines as wages rose. Investment have declined to 4.8 percent in 2014. was supported by solid corporate profits, Since February 2013 headline inflation has growing confidence, record low interest been below the Central Bank’s 1.5-3.5 per- rates and final disbursements from the EU’s cent target range and since July 2014 con- previous financial perspective (budget). On sumer prices have fallen due to energy and Growth in Poland stabilized at 3.4 the production side, economic activity has food price declines. The main policy interest been led by strong growth in financial ser- rate remains at record low of 1.5 percent. percent in the first half of 2015 and vices, telecommunications and industry. Poland has further strengthened its trade was mainly driven by domestic de- Solid economic growth is creating more and financial linkages with the euro area mand. Growth is projected to pick up jobs. According to the latest LFS survey, where Germany as its main trading part- the unemployment rate declined by almost ner, accounts for almost 30 percent of ex- in the second half of the year, to reach 2 percentage points over the year, from 9.1 ports. In the first half of 2015, the trade 3.6 percent for 2015 as a whole. Job percent in the 2nd quarter of 2014 to 7.4 balance turned into a US$3.7 billion sur- creation and real increases in wages percent in the 2nd quarter of 2015. In the plus, from a US$1.1 billion deficit in the same period, the number of employed first half of 2014. After the current account and pensions have resulted in faster increased by 1.2 percent (193,000), with 2.4 deficit widened from 1.3 percent of GDP poverty reduction. percent (282,000) more jobs created in the in 2013 to 2.3 percent of GDP in 2014, a We project growth to increase gradu- private sector, offsetting the 2.3 percent significant improvement is expected in (89,000) jobs lost in the public sector. An- 2015. A moderation of foreign capital ally to 3.9 percent over the medium nual growth in nominal wages and salaries flows or increased portfolio investment term. We project poverty to continue slowed to 3.1 percent in the second quarter volatility pose limited threats to Poland’s to decline through 2017. of the year, from 4.1 percent in the first external balances. Gross external debt quarter, but real purchasing power was increased from 69.6 percent of GDP in boosted as consumer prices fell by 0.9 per- 2013 to 71.9 percent of GDP in 2014. FIGURE 1 Poland / Contributions to annual GDP growth FIGURE 2 Poland / Actual and projected poverty rates (2004 -2017) and GDP per capita (2000-2017) 20 30000 18 25000 16 14 20000 Poverty Rate (%) GDP per capita 12 10 15000 8 10000 6 4 5000 2 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 $2.5/day PPP $5/day PPP GDP per capita Sources: World Bank team estimates based on Central Statistical Office. Sources: World Bank (see notes to Table 2). MPO 76 Oct 15 78  ●   World Bank ECA Economic Update October 2015 Fiscal consolidation enabled Poland to exit demands and gradually push up core and the EU Excessive Deficit Procedure this Spring, one year ahead of schedule. The headline inflation toward their reference rate, while the decline in food prices will Challenges general government deficit declined to 3.2 also be halted by the country -wide percent of GDP in 2014, from 4.0 percent drought. Robust investment growth of Despite the relatively benign forecast, the in 2013 owing to a rebound in direct and around 8 percent in 2015-2016 will be balance of risks for the Polish economy is indirect taxes, in line with more dynamic backed by solid enterprise profits, record - slightly skewed to the downside. The domestic demand, the continued freeze of low costs of credit and sizeable EU funds. main challenges are external and largely the central government’s wage bill, while These positive domestic demand trends indirect- starting from geopolitical ten- interest payments declined due to record should also boost tax collection. While the sions and protracted conflict in Eastern low yields of new bonds and changes to fiscal stance is set to remain fairly con- Ukraine. Unfavorable economic develop- the pension system. The latter also con- servative, in line with fiscal rules, the pace ments both in close (EU) or more distant tributed to a fall in public debt, from 55.7 of consolidation will moderate as the con- (China) markets may affect Poland direct- percent of GDP in 2013, to 50 percent of straints imposed by the EDP procedure ly and indirectly and undermine growth GDP in 2014. are lifted (e.g. wages maybe unfrozen for prospects through trade, financial and the first time in six years). The headline confidence channels. But internally, par- deficit is expected to decline modestly, to liamentary elections pose a risk of height- Outlook 2.9-2.8 percent of GDP in 2015-2016. Some structural shifts, however, are expected as ened political instability with the potential for some reversals of the current conserva- social expenditures rise with the introduc- tive fiscal policies. Upside risks include a Going forward, we project Poland’s econ- tion of new social benefits and programs stronger recovery in the Eurozone or fur- omy to grow at a rate above 3½ percent, supporting families with children, the ther declines in oil prices, which benefit with negligible internal and external im- elderly or more generous pensions’ index- Poland as a large oil importer. balances. Domestic demand is likely to ation result from commitments made dur- In the medium-term, Poland needs to im- remain the main locomotive of growth ing the election year. Funding new spend- prove the efficiency of public finances and amid stronger private consumption and ing items will require increased effective- do more to ensure that economic growth solid investment growth. Private con- ness of public spending, and more effi- includes better the poor. Doing business sumption growth is forecast to reach 3.4- cient tax administration. reforms could encourage productivity and 3.6 percent in 2015-2016 backed by contin- Underpinned by these developments, we innovation. Lastly, the country needs to ued increases in disposable incomes fol- project poverty, measured by the US$5-a- manage the transition towards a low- lowing the cyclical upswing in employ- day in 2005 PPP, to decline to 4.6 percent emissions economy. ment. This is expected to strengthen wage in 2015 and fall to 4.2 percent by 2017. TABLE Poland / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 1.8 1.7 3.4 3.6 3.7 3.9 Private Consumption 0.9 1.2 3.0 3.4 3.5 3.7 Government Consumption 0.2 2.1 4.7 2.3 1.4 1.4 Gross Fixed Capital Investment -1.5 1.1 9.2 8.0 7.6 7.8 Exports, Goods and Services 4.3 4.8 5.7 5.8 6.3 6.6 Imports, Goods and Services -0.6 1.8 9.1 7.1 7.0 7.3 Real GDP growth, at constant factor prices 1.8 1.8 3.2 3.7 4.0 4.0 Agriculture -4.7 6.3 3.8 0.9 1.7 0.6 Industry 2.0 1.3 4.1 4.4 5.2 4.8 Services 2.0 1.9 2.9 3.5 3.7 3.9 Prices Inflation (GDP price deflator) 2.2 1.1 0.8 -0.5 1.1 1.5 Inflation (Consumer Price Index) 3.7 1.2 0.2 -0.8 1.2 1.5 Inflation (Private Consumption Deflator) 3.2 0.7 0.1 -0.8 1.2 1.5 Inflation (Consumer Price Index) 3.7 1.2 0.2 -0.8 1.2 1.5 Current Account Balance (% of GDP) -3.6 -1.3 -1.9 -1.5 -1.7 -2.3 Fiscal Balance (% of GDP) -3.7 -4.0 -3.2 -2.9 -2.8 -2.5 Poverty Rate a, b, c Poverty rate ($2.5/day 2005 PPP terms) 0.9 0.8 0.8 0.8 0.7 0.7 Poverty rate ($5/day 2005 PPP terms) 5.1 5.0 4.8 4.6 4.4 4.2 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n 2004-EU-SILC Survey, 201 2-EU-SILC survey, . (b) P ro jectio n using po int-to -po int elasticity (2004-201 with pass-thro ugh = 0.7 based o n GDP per capita co nstant P P P . 2) � (c) A ctual data: 201 2. Data fo r 201 3-4 are estimates, data fro m 201 5 thro ugh 2017 are pro jectio ns. MPO 77 Oct 15 Macro Poverty Outlook Reports ●  79 erty is projected to have declined from ROMANIA Recent developments 35.8 percent in 2011 to 28.4 percent in 2014 using the US$5.00/day PPP poverty line The cut in the VAT rate for food in June At 3.7 percent (y-o-y), Romania achieved one 2015 has increased the purchasing power of of the highest growth rates in the EU in the Romanians, particularly for the poorest 2014 first half of 2015. On the production side, members of society for whom food is a larg- Population, million 21.2 growth was propelled by a recovery in con- er portion of their budgets. The budget was GDP, current US$ billion 203.7 struction and industry, in particular the pro- in surplus in the first 7 months of 2015 due GDP per capita, current US$ 9586 duction of machinery and transport equip- to strong revenue performance and lower Poverty rate ($2.5/day 2005 PPP terms) a 11.1 ment. On the demand side, it was fueled by than budgeted spending. Revenues grew by Poverty rate ($5/day 2005 PPP terms) a 32.6 strong growth of private consumption and 9.9 percent (y-o-y) between January and July Gini Coefficient b 34.9 investment. Private consumption increased 2015, largely driven by increases in revenues Life Expectancy at birth, years c 74.5 by 5.4 percent (y-o-y) due to increases in from PIT, VAT and excises. Spending was Sources: World Bank, WDI, M acro Poverty Outlook, and ECA TSD. wages and a decline in the VAT rate for food contained due to lower interest payments Notes: from 24 percent to 9 percent in June 2015. and public investment. The government is (a) M ost recent value (2012). (b) Gini data show most recent WDI value (2012). Private investment grew strongly. Although expected to meet the fiscal headline deficit (c) Life Expectancy data show most recent WDI value (2013). improving, public investment remained of 1.86 percent of GDP in 2015. subdued reflecting a lower-than expected The reduction of the VAT rate for foodstuff absorption of EU funds. Fueled by domestic from 24 percent to 9 percent starting in June consumption, import growth outpaced ex- 2015 drove consumer prices into negative port growth. Yet, export growth was strong territory (-1.9 percent yoy in August). The Real GDP growth was strong in the at 6.2 percent (y-o-y) driven by exports of low inflation environment enabled the cen- first half of 2015, driven by private con- manufacturing goods and services. Overall, tral bank to maintain relaxed monetary sumption and investment. Romania’s the trade surplus declined slightly y-o-y, conditions and ample liquidity in the mar- while the current account deficit remained ket. The central bank kept its policy rate at macroeconomic situation remains low at around 0.4 percent in terms of GDP as 1.75 percent in its July session. Credit sound: the consolidated budget is in sur- of end-June 2015. growth remains timid, with credit to house- plus, the current account deficit low and Growth has led to increases in wages as holds expanding by 3.4 percent in July 2015, employment and labor force participation while credit to corporations fell by 4.7 per- inflation negative. Real GDP growth is remained constant and job creation low. cent. Non-performing loans declined sub- expected to reach 3.6 percent in 2015. Labor force participation was 64 percent stantially, from 21.9 percent at the end of Poverty is on a downward trajectory in March, below the 70 percent national 2013 to 12.8 percent at the end-July 2015. and has reached historical lows. Risks to target and lower than the EU28 average. Unemployment has been broadly stable the outlook remain significant. Faster implementation of structural reforms over the last year and remains at 6.8 per- cent as of end-July, below the EU average Outlook will be important to accelerate growth. of 9.8 percent. Yet, youth unemployment remains high (at 23 percent in March), The economic outlook for the rest of 2015 above the EU average of 20.1 percent. Pov- and for 2016 is positive. Real GDP growth FIGURE 1 Romania / Contributions to annual GDP growth FIGURE 2 Romania / Actual and projected poverty rates (2006-2017) and GDP per capita (2000-2017) 50 20000 45 18000 40 16000 35 14000 Poverty Rate (%) GDP per capita 30 12000 25 10000 20 8000 15 6000 10 4000 5 2000 0 0 2008 2017 2000 2001 2002 2003 2004 2005 2006 2007 2009 2010 2011 2012 2013 2014 2015 2016 $2.5/day PPP $5/day PPP GDP per capita Sources: World Bank. Sources: World Bank (see notes to Table 2). MPO 78 Oct 15 80  ●   World Bank ECA Economic Update October 2015 in 2015 is projected to slow down slightly rate of 1.75 percent for the rest of 2015 and tion, global financial market volatility, the in the second half due to a drought- in early 2016. Continued recovery of do- expected increase in the global interest induced decline in agricultural production mestic demand and growth in employ- rates and anemic Eurozone growth. They and to reach a solid 3.6 percent for the ment and real wages, aided by low infla- could be mitigated through prudent fiscal entire year. It is expected to accelerate to tion should boost real incomes and lead to policies, an accelerated implementation of 3.9 percent in 2016, supported by strong further declines in poverty incidence. The structural reforms and a better absorption domestic consumption and investment. US$5.00/day 2005PPP poverty rate is pro- of the EU funds. Romania’s macro-fiscal The current account deficit is expected to jected to decline to 26.3 percent in 2015 fundamentals are sound, and export modestly widen over the medium term, as then further to 24.2 percent in 2016 and growth has remained solid even in the imports increase driven by demand. The 22.1 percent in 2017. Similarly, the context of weak external demand, sug- fiscal deficit is expected to widen in 2016. US$2.50/day 2005PPP poverty rate is like- gesting that Romania is in a good position The Fiscal Code approved by the Parlia- ly to fall from 9.3 percent in 2014 to 8.4 to weather potential external shocks. ment in September envisages several tax percent in 2015 and to 6.7 percent by 2017. On the upside, improved credit conditions, cuts starting in January 2016, including in Accelerating structural reform implementa- enhanced investment sentiment and grad- VAT from 24 percent to 20 percent. The tion will be important to sustain growth. ual strengthening of economic activity in Fiscal Council estimates that the fiscal Key reform areas include public expendi- the EU would boost growth prospects. impact of the measures presented would ture management, tax administration, ener- be around 1.1 percent of GDP in 2016. gy, transport, cadaster and property regis- Consumer prices will remain in negative tration, and the public enterprise sector. territory in 2015, thanks to the one -off effect of the June VAT rate cut and helped by lower oil prices and weak inflation in the EU. The annual inflation rate will like- Challenges ly remain negative in the first half of 2016 due the VAT rate cut. With deflation in Risks to this outlook remain significant. sight for the foreseeable future, the NBR is Key risks include ad-hoc spending expected to maintain the current policy measures in the run-up to the 2016 elec- TABLE Romania / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 0.4 3.5 2.8 3.6 3.9 4.1 Private Consumption 1.3 1.3 4.5 6.1 5.7 5.1 Government Consumption 3.3 -1.2 13.7 2.9 3.4 3.5 Gross Fixed Capital Investment 11.3 -3.3 -3.5 9.7 10.1 9.8 Exports, Goods and Services -1.8 13.5 8.1 6.6 5.9 5.3 Imports, Goods and Services 1.4 2.4 7.7 9.8 8.6 7.3 Real GDP growth, at constant factor prices 0.3 3.5 2.5 3.3 3.8 3.9 Agriculture -22.4 26.6 1.5 -4.0 5.3 3.3 Industry -0.9 8.0 3.6 2.9 2.9 3.3 Services 5.7 -3.0 1.8 5.1 4.2 4.5 Prices Inflation (GDP price deflator) 6.0 5.0 1.4 0.8 2.8 3.6 Inflation (Consumer Price Index) 3.3 4.0 1.1 -0.3 1.3 2.6 Current Account Balance (% of GDP) -3.9 -1.1 -0.4 -1.2 -2.0 -2.3 Fiscal Balance (% of GDP) -2.5 -2.5 -1.9 -1.9 -2.1 -2.2 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 11.1 10.1 9.3 8.4 7.6 6.7 Poverty rate ($5/day 2005 PPP terms) 32.6 30.2 28.4 26.3 24.2 22.1 Sources: World Bank, M acroeconomics and Fiscal M anagement Global Practice, and Poverty Global Practice. Note: f = forecast. (a) Calculations based on 2006-EU-SILC Survey, 201 2-EU-SILC Survey. (b) Projection using point-to-point elasticity (2006-201 with pass-through = 0.7 based on GDP per capita constant PPP. 2) � (c) Actual data: 2012. Data for 2013-4 are estimates, data from 201 5 through 2017 are projections. MPO 79 Oct 15 Macro Poverty Outlook Reports ●  81 percent (y/y) contraction in imports dur- RUSSIAN Recent developments ing the first quarter of 2015. Depreciation also boosted export performance in cer- tain sectors such as chemical production FEDERATION Russia’s recession, which began in the fourth quarter of 2014, deepened signifi- and machine-building. Nevertheless, the pass-through effect of cantly in the first half of 2015. In the first the depreciation pushed inflation to levels quarter of 2015 growth dropped from an not seen since 2002. 12-month consumer 2014 anemic but positive 0.4 percent (y/y) to price index (CPI) inflation peaked at 16.9 Population, million 146.1 negative 2.2 percent, and in the second percent in March 2015, largely driven by GDP, current US$ billion 1860.6 quarter the economy contracted at a rate rising food prices. By February food prices GDP per capita, current US$ 12736 of 4.6 percent. Domestic demand contin- had increased by 23.3 percent (y/y), after Poverty rate ($2.5/day 2005 PPP terms) a 0.8 ues to decline, and a combination of lin- rising by 15.4 percent in 2014. Food -price Poverty rate ($5/day 2005 PPP terms) a 7.3 gering policy uncertainty, a weak domes- inflation is hitting poor households partic- Gini Coefficient b 41.6 tic market and high capital costs prompt- ularly hard. Life Expectancy at birth, years c 70.9 ed a sharp contraction in investment. To support credit growth the CBR Meanwhile, consumption dropped by 6.4 launched a cautious monetary-easing cy- Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: percent in the first quarter (y/y), its fastest cle in January, cutting policy rates by a (a) M ost recent value (2012). (b) Gini data show most recent value (2012). rate since the 1998 crisis. cumulative 600 basis points to 11 percent (c) Life Expectancy data show most recent value (2013). Consumer demand dropped as double- before pausing the cycle in September as digit inflation eroded real wages and in- inflation remained elevated. Measures to comes, which fell by an average of 8.5 support the financial sector successfully The Russian economy continues its diffi- percent in the first half of 2015. However, contained systemic risks. the deterioration of real wages was also In January the government also initiated a cult adjustment to the 2014 terms-of- the primary mechanism through which RUB2.4 trillion anti-crisis program, which trade shock amid a tense geopolitical con- the labor market adjusted to lower de- appears to have contained systemic risks. text marked by ongoing international mand, and unemployment increased only Low oil prices ushered in a difficult period sanctions. In the first half of 2015 the slightly from 5.3 percent in 2014 to 5.6 of fiscal consolidation as downward pres- percent in the first half of 2015. sure on federal revenue continued. Fiscal economy shrank by 3.5 percent (y/y), as In the first half of 2015 the ruble depreciat- balances deteriorated in the first half of the contraction in domestic demand accel- ed by 38.9 percent against the US dollar 2015 due to a shortfall in oil revenues and erated. Oil and gas prices continued to (y/y), in line with the decline in oil prices. the frontloading of expenditures, dimin- fall, leading to a depreciation of the ruble. Meanwhile, the Central Bank of Russia’s ishing Russia’s fiscal buffers. By end-2015 (CBR) successful transition to a free- real public spending is expected to fall by 5 The pass-through effect of this deprecia- floating exchange rate allowed imports to percent (y/y) despite the temporary in- tion fueled inflation, eroding real wages adjust to a real effective exchange rate crease in the first half of the year. Falling oil and incomes. Poverty rates are increas- depreciation of more than 17 percent, dou- revenues constrained the government’s ing, and progress in promoting shared bling the current-account balance to 8 ability to counter the decline in real income, prosperity has stalled. percent of GDP. Depreciation weakened and increases in both pensions and social domestic demand and contributed to a 25 benefits were insufficient to offset inflation. FIGURE 1 Russian Federation / GDP Growth by Sector FIGURE 2 Russian Federation / Actual and projected pov- (percent) erty rates and real GDP per capita, 2000-2017 15 50 25000 45 10 40 20000 5 35 Poverty Rate (%) GDP per capita 30 15000 0 25 20 10000 -5 15 -10 10 5000 5 -15 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Consumption Gross Fixed Capital Formation Change in inventories Export Import Stat error $2.5/day PPP $5/day PPP GDP per capita Sources: Russian Statistical Authorities and World Bank staff calculations. Sources: World Bank (see notes to Table 2). MPO 80 Oct 15 82  ●   World Bank ECA Economic Update October 2015 The erosion of real income increased pov- improve allocative efficiency and bolster vital banks could increase pressure on erty and exacerbated the vulnerability of long-term competitiveness. fiscal buffers. Fiscal sustainability risks are households in the lower 40 percent of the Russia’s economy is projected to contract already rising, and the revenue uncertain- income distribution. The moderate poverty by 3.8 percent in 2015 and 0.6 percent in ty generated by slow growth and volatile rate (US$7.90 in 2011 PPP) was estimated 2016 before rebounding to a modest oil prices is complicating medium-term at 6.8 percent in 2014, while extreme pov- growth rate of 1.5 percent in 2017. The budget planning. erty (US$3.85 in 2011 PPP) has remained recession, and particularly the steep de- Dependence on fiscal transfers will remain below 1 percent since 2007. Progress in cline in households’ purchasing power, is a source of vulnerability for households in shared prosperity began to stall in 2014, expected to lead to the first significant the lower 40 percent of the income distri- when income growth among households increase in the poverty rate since 1999, bution, as inflation is likely to continue in the lower 40 percent of the distribution with moderate poverty rising to 7.8 per- undermining the real value of these trans- fell below the overall average, and the cent in 2015 and 8.1 percent in 2016. fers. Broad-based employment growth growth of the middle class halted in 2014. This outlook assumes that government will be critical to poverty reduction and and central bank policies will continue to the expansion of the middle class. support Russia’s macroeconomic adjust- Despite the serious short-term challenges Outlook ment over the projection period, but poli- cy uncertainty remains high. posed by Russia’s economic transfor- mation, the reallocation of productive factors could substantially enhance its Adverse external conditions pose a seri- medium-term growth potential. However, ous challenge to Russia’s growth pro- spects. The continued impact of the ad- Challenges completing the adjustment process will require a supportive policy environment, justment to lower oil prices in a context of and without deep structural reforms Rus- ongoing international sanctions will cause Russia faces complex challenges as it sia could fall into a medium-term low- the Russian economy to contract in 2015. strives to complete the structural transfor- growth trap. Russia’s medium-term growth trajectory mation that began with its recent macroe- will hinge on its ability to adapt to new conomic adjustment. economic realities. While the process of Despite recent stabilization measures fi- structural transformation will be difficult, nancial-sector risks remain elevated, and it also presents a valuable opportunity to further recapitalization of systemically TABLE Russian Federation / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 3.4 1.3 0.6 -3.8 -0.6 1.5 Private Consumption 7.7 4.9 1.2 -9.0 -1.5 1.3 Government Consumption 2.6 1.1 -0.1 -2.9 -2.0 0.0 Gross Fixed Capital Investment 6.7 0.9 -2.0 -8.8 -1.0 5.3 Exports, Goods and Services 1.1 4.6 -0.1 1.0 1.5 2.5 Imports, Goods and Services 8.7 3.8 -7.9 -22.0 1.5 6.0 Real GDP growth, at constant factor prices 3.6 1.7 0.9 -3.9 -0.6 1.7 Agriculture -3.4 4.2 1.3 3.0 1.0 1.0 Industry 2.3 0.4 0.6 -2.0 1.5 2.0 Services 4.9 2.3 1.1 -5.5 -2.0 1.5 Prices Inflation (GDP price deflator) 7.4 5.0 7.2 13.9 6.1 3.4 Inflation (Consumer Price Index) 5.1 6.8 7.8 15.5 7.5 5.0 Current Account Balance (% of GDP) 3.5 1.7 3.1 7.7 6.8 5.0 Fiscal Balance (% of GDP) 0.4 -1.3 -1.2 -4.3 -2.1 -1.7 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 0.8 0.7 0.7 0.8 0.9 0.8 Poverty rate ($5/day 2005 PPP terms) 7.3 6.9 6.8 7.8 8.1 7.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2011-HB S and 2012-HB S. (b) P ro jectio n using annualized elasticity (2011-201 with pass-thro ugh = 1based o n GDP per capita co nstant P P P . 2) � (c) A ctual data fo r 2012; 2013-14 are estimates; 201 5-17 are pro jectio ns. MPO 81 Oct 15 Macro Poverty Outlook Reports ●  83 needed fiscal consolidation program, may SERBIA Recent developments create adverse impacts on some house- holds. While the immediate poverty im- pact may be limited since less than 10 per- Serbia’s economy moved out of recession cent of the working poor (living below 60 in Q2 2015, growing by 1 percent year-on- percent median income) work in the pub- 2014 year (y/y). Activity is recovering following lic sector, further public sector retrench- Population, million 7.1 the 1.8 percent contraction in GDP in 2014, ments may have negative impacts on fu- GDP, current US$ billion 43.8 which was mainly due to the May 2014 ture poverty. The poverty impact of the floods. The weakness in consumption in 2014 nominal cuts in pensions, which ac- GDP per capita, current US$ 6181 the second quarter was less than expected, count for close to one quarter of income Poverty rate ($2.5/day 2005 PPP terms) a 1.7 as private sector wages started to rise, among households in the bottom two Poverty rate ($5/day 2005 PPP terms) a 14.5 partially offsetting cuts in public sector quintiles, is also eased because the cuts Gini Coefficient b 29.7 wages. Exports were also supportive, were progressive. However, the freezing Life Expectancy at birth, years c 74.8 along with investment, although govern- of pension indexation will be felt across Sources: World Bank, WDI, and M acro Poverty Outlook. ment capital spending was weak. the board, unless partially compensated Notes: (a) M ost recent value (2010). Labor market performance has also re- for, e.g., by continued employment. (b) Gini data show most recent WDI value (2010). (c) Life Expectancy data show most recent WDI value (2013). cently shown some improvement. The General government fiscal performance unemployment rate of 17.9 percent in Q2 was better than projected in the first half 2015, although up from 16.8 percent in Q4 of 2015. Revenues were significantly high- 2014 due to a smaller number of informal er due to one-off factors including the sale sector jobs, was down relative to 20.3 per- of 4G licenses and transfer of net income Serbia’s economy moved out of recession cent a year earlier. The activity rate also from SOEs. Expenditures were broadly increased, moving up to 51.4 percent. under control, with wage and pension in Q2 2015, as activity recovered from With public sector wages frozen, overall spending restrained. As a result, the re- the 2014 floods. Growth of 0.5 percent is real wages fell again over H1 2015, down vised 2015 fiscal deficit projection is 4.3 projected for 2015, rising to around 2 1.6 percent y/y following a contraction of percent of GDP (versus 5.3 percent origi- 0.7 percent over 2014 as a whole. nally), with public debt-to-GDP set to percent for 2016 and 2017, supported by Poverty went up after the crisis and during reach 76 percent at end-2015 (up from 72.4 exports and domestic demand. Poverty, the recessions of 2012 and 2014, mainly due percent at end-2014 in part due to valua- which reached an estimated 14.5 percent to losses in employment and labor income. tion effects from the dollar’s appreciation (living under $5/day PPP) in 2014, is Using the standardized regional moderate over the year). poverty line of $5/day in 2005 PPP, the pov- External sector performance has also im- expected to decline to 13.9 percent in erty rate peaked at 15.1 percent in 2010. proved with the strengthening Euro Area 2016. High degree of vulnerability re- After falling in 2011, poverty rose slightly recovery. Merchandise exports grew by 8 mains due to still weak labor markets again in 2012 and 2014 to an estimated 14.8 percent y/y in H1 2015 in euro terms with percent and 14.5 percent, respectively. service exports and remittances up by 15 and, if not mitigated, the impacts of fiscal Recent spending freezes, cuts in public percent and 13 percent respectively. As a consolidation measures. wage and pensions, and increases in elec- result, the current account deficit (in euro tricity tariffs, as part of the government’s terms) declined by 30 percent in the first FIGURE 1 Serbia / Contribution to Growth 2007-2017 FIGURE 2 Serbia / Actual and projected poverty rates and real GDP per capita, 2000-2017 6.0 30 14000 25 12000 4.0 10000 20 Poverty Rate (%) GDP per capita 2.0 8000 15 0.0 6000 10 4000 -2.0 5 2000 -4.0 2010 2011 2012 2013 2014 2015 2016 2017 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Private consumption Government consumption Investments Net exports GDP, real growth $2.5/day PPP $5/day PPP GDP per capita Sources: WB staff calculations based on Statistical Office data. Sources: World Bank (see notes to Table 2). MPO 82 Oct 15 84  ●   World Bank ECA Economic Update October 2015 half. The dinar has remained broadly stable come from the recovery of industrial out- against the euro over the year to date, de- clining against a stronger US dollar. Spillo- put, following the impact of the 2014 floods, and improved export performance. Challenges vers from the Greek crisis to Serbia’s bank- Construction and services are also ex- ing sector have been limited to date with pected to be supportive. However, agri- While recognizing the positive fiscal con- the authorities taking a proactive policy culture value added is expected to fall by solidation progress in 2015-to-date, there response, for example, in terms of en- about 8 percent in 2015 compared to 2014 remains the need for sustained implemen- hanced monitoring of Greek bank subsidi- as a result of a recent drought. Declines in tation of the government’s fiscal consoli- aries and in communications to the public. private and public consumption will be dation program and related structural Twelve-month consumer price inflation offset by a rise in investments and net reforms. This is crucial in order to main- remained in the range of 2 percent over exports (which will also support the nar- tain macro stability and to create an envi- H1, below the target band of the National rowing in the current account deficit to 4.7 ronment conducive for higher growth and Bank of Serbia (NBS) of 4 ± 1.5 percent, percent of GDP). poverty reduction over the medium term. although it slowed down to 1 percent (y/ The fragile though positive macro-fiscal The potential distributional impacts of y) in July, primarily as a result of lower outlook is expected to slowly bring back comprehensive structural reforms, while food price inflation. Core inflation peaked poverty reduction, albeit with a continued supportive of future overall employment in March at 2.9 percent, falling thereafter. high level of vulnerability. Poverty meas- and income growth, are likely to pose There is expected to be a more significant ured at the $5/day poverty line is expected challenges to poverty reduction in the rise in inflation following August’s elec- to decline slowly to 14.3 percent in 2015 short term, requiring mitigating measures. tricity price increase, bringing inflation and 13.9 percent in 2016, with some im- Moreover, despite recent improvements, back into the target band by year-end. provements in labor demand and employ- labor force participation and employment ment expansion. However, the expected ratios are still low while unemployment is decline in agriculture output for 2015 is high, especially for youth. Social protec- Outlook likely to increase rural poverty. While food price increases have been modest, tion and job opportunities to mitigate ad- verse impacts and facilitate access to pro- the recent rise in electricity tariffs ap- ductive employment need to be an im- Growth is expected to pick up in the sec- proved in August 2015 is expected to in- portant part of the policy agenda. ond half of 2015, moving full-year growth crease energy stress, particularly on poor up to 0.5 percent (compared to a previous households, who have a relatively higher projection of nil). Most of the growth will share of total expenditures on energy. TABLE Serbia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -1.0 2.6 -1.8 0.5 1.5 2.0 Private Consumption -2.0 -0.6 -1.3 -0.8 0.5 1.5 Government Consumption 2.0 -1.1 0.1 -3.0 -1.8 -3.1 Gross Fixed Capital Investment 13.2 -12.0 -2.7 5.6 4.8 7.4 Exports, Goods and Services 0.8 21.3 3.9 9.0 4.8 6.7 Imports, Goods and Services 1.4 5.0 3.3 5.9 3.0 5.6 Real GDP growth, at constant factor prices -0.8 3.3 -2.0 0.1 1.5 1.8 Agriculture -17.3 20.9 0.8 -8.0 9.0 1.8 Industry 2.4 4.2 -7.1 6.7 4.0 2.5 Services 0.4 0.4 0.1 -1.6 -0.9 1.4 Prices Inflation (GDP price deflator) 6.3 5.4 1.9 2.0 3.0 3.6 Inflation (Consumer Price Index) 7.8 7.8 2.9 1.3 .. .. Inflation (Private Consumption Deflator) 7.3 6.2 2.6 1.6 3.2 4.0 Inflation (Consumer Price Index) 7.3 7.7 2.1 1.6 3.4 4.0 Current Account Balance (% of GDP) -11.6 -6.1 -6.0 -4.0 -3.8 -3.9 Fiscal Balance (% of GDP) -7.2 -5.6 -6.7 -4.0 -3.9 -3.0 Poverty Rate Poverty rate ($2.5/day PPP terms) 1.8 1.7 1.7 1.7 1.7 1.7 Poverty rate ($5/day PPP terms) 14.8 14.2 14.5 14.3 13.9 13.4 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. In annual percent change unless indicated otherwise. Calculations based on 2006-HBS Survey, 2010-HBS survey, . Projection using Point-to-point elasticity (2006-2010) a) Calculations based on 2006-HBS Survey, 2010-HBS survey. b) Projection using point-to-point elasticity (2006-2010) with pass-through = 1 based on GDP per capita constant PPP. c) Data for 2012 through 2014 are estimates, data for 2015-2017 are projections. MPO 83 Oct 15 Macro Poverty Outlook Reports ●  85 Consumer price inflation declined by 0.3 SLOVAK Recent developments percent in the first eight months of 2015 compared to a year ago driven by declin- ing fuel, electricity, and food prices. REPUBLIC GDP growth increased to 3.2 percent in Q2-2015 supported by stronger domestic The external current account surplus nar- rowed to 0.1 percent of annual GDP in the demand. Investment expanded by 12 per- first half of 2015 from 0.8 percent a year cent and was the key driver of growth as earlier as the trade surplus narrowed sig- 2014 implementation of EU-funded projects nificantly. Trade dynamics was affected intensified in the end of the current fi- by strong external demand for vehicles Population, million 5.5 nancing period. Private consumption con- and even stronger domestic demand for GDP, current US$ billion 99.8 tinued to strengthen, boosted by growing investment and intermediary goods GDP per capita, current US$ 18258 incomes and employment, low inflation (vehicles, machinery and electronic equip- Gini Coefficient a 26.6 and easing of credit conditions. Exports ment, and basic metals). Life Expectancy at birth, years b 76.1 expanded at a robust rate as a result of The fiscal position is expected to improve recovery in external demand but with in 2015, thanks mostly to revenue Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: faster expansion of imports the contribu- measures. Revenue has turned out better (a) Gini data show most recent WDI value (2011). (b) Life Expectency data show most recent WDI value (2013). tion of net exports to growth was nega- than expected, especially from valued tive. Manufacturing, construction, and added tax and corporate income tax. Fi- trade, transport and tourism which gener- nancial corrections related to drawing of ated most of the growth in Q2-2015. EU funds and spending of local govern- Resurgence of economic activity support- ments represent bring uncertainty to the Economic activity accelerated with GDP ed continuing improvements in the labor implementation of the budget. growth reaching 3.2 percent in Q2-2015 market. Job creation intensified in all sec- The banking sector remains liquid, well tors but construction with manufacturing, capitalized and profitable and nearly 70 supported by stronger domestic demand. professional services, and public admin- percent of the banking system is already Improvements in the labor market contin- istration contributing the most to employ- subject to direct supervision from the ECB ued: employment expanded in almost all ment growth. Unemployment fell faster under the Single Supervisory Mechanism. than in previous years and reached 11.7 The National Bank of Slovakia will contin- sectors, unemployment declined faster percent in July 2015, down from 13.1 per- ue to play an important role in banking than in previous years, and wages in- cent a year earlier but remained high com- supervision. creased in line with rising productivity pared to the rest of the EU. Slovakia has Lending to non -financial corporations relatively large youth and long-term un- remained sluggish despite low interest and low inflation. The outlook is brighten- employment. At he same time, Slovakia rates. At the same time, lending to ing with GDP expected to gradually pick has a relatively low share of people living households, especially consumer and up from 3.1 percent in 2015 to 3.5 percent at risk of poverty or social exclusion—19.8 housing lending, continued to expand. percent in 2013 compared to 24.5 percent Growth of household deposits slowed in by 2017 as the recovery of domestic de- in the EU and 30 percent in the EU New 2015 in line with increased household mand takes hold. Members States. consumption. FIGURE 1 Slovak Republic / Contributions to annual growth FIGURE 2 Slovak Republic / Percent of population at risk of poverty or social inclusion, % Net exports 35 15 Changes in inventories Gross fixed capital formation 30 Consumption 10 GDP 25 Percentage point 5 20 Percent 15 0 10 EU -5 5 -10 0 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sources: Statistical Office of Slovak Republic, World Bank. Source: Eurostat. MPO 84 Oct 15 86  ●   World Bank ECA Economic Update October 2015 With lower oil import prices and a strong- Outlook er euro against the dollar, Slovakia is like- ly to have another year of deflation in Challenges 2015. As consumption strengthens further The outlook for the Slovak economy is and the pressures from falling oil prices The outlook is subject to downside risks improving. GDP is projected to grow by wane, consumer prices are likely to slowly coming from the external environment. 3.1 percent in 2015 and accelerate gradual- increase from 1.2 percent in 2016 to 1.8 Risks are related mostly to the strength ly to 3.5 percent by 2017. The growth mo- percent in 2017. and sustainability of recovery in the EU as mentum is likely to be supported by ro- The external current account surplus is well as the fallout of economic slowdown bust domestic demand. With employment expected to reach 0.7 percent of GDP in in China. and wage growth firming, inflation still 2015 and 1.3 percent in 2017. Improved Structural reforms associated with im- low, and credit conditions improving, exports prospects are based on expecta- provements in the business environment, consumption is set to increase its im- tions about continuing recovery in in the upgrade of infrastructure and maintaining portance for growth in the medium term. Eurozone and enhanced competitiveness labor market flexibility could ensure Slovak At the same time, government consump- of Slovak exporters. economy is set on a higher growth path. tion growth is likely to be subdued, con- Government deficit is expected to narrow strained by the increasing fiscal consolida- from 2.6 percent of GDP in 2015 to 1 per- tion in 2016 and 2017. Investment growth cent by 2017. Consolidation of fiscal ac- is likely to start moderating in 2016, affect- counts relies on better tax compliance but ed by slow disbursement of EU funds in will also require substantial savings in the beginning of the new financing period. spending. Spending by local governments Stronger exports are expected to offset the would continue to create uncertainty while reduced reliance on investment as an im- general elections in 2016 are likely to put an petus for growth in the medium term. upward pressure on overall spending. TABLE Slovak Republic / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 1.6 1.4 2.4 3.1 3.3 3.5 Private Consumption -0.4 -0.7 2.2 2.3 2.8 3.0 Government Consumption -2.0 2.4 4.4 2.5 1.6 1.0 Gross Fixed Capital Investment -9.3 -2.7 5.7 6.1 3.6 3.8 Exports, Goods and Services 9.3 5.2 4.6 4.6 5.9 6.3 Imports, Goods and Services 2.6 3.8 5.0 5.3 5.5 5.8 Real GDP growth, at constant factor prices 2.6 1.0 2.2 3.1 3.3 3.5 Agriculture 2.8 19.5 -1.3 1.0 1.3 1.5 Industry 1.1 -3.5 2.6 4.7 4.9 5.2 Services 3.4 2.6 2.2 2.4 2.6 2.7 Prices Inflation (GDP price deflator) 1.3 0.5 -0.2 0.5 1.9 1.9 Inflation (Consumer Price Index) 3.6 1.4 -0.1 -0.1 1.2 1.8 Current Account Balance (% of GDP) 0.9 1.5 0.1 0.7 1.3 1.4 Fiscal Balance (% of GDP) -4.2 -2.6 -2.9 -2.6 -1.9 -1.0 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 85 Oct 15 Macro Poverty Outlook Reports ●  87 (ESA2010 methodology), the deficit declined SLOVENIA Recent developments further in the first quarter of 2015 to 4.7 per- cent of GDP, on track to reach the budgeted 2.9 percent by the end of the year. This was After the economy grew by 3 percent in achieved mainly through better revenue 2014, robust growth continued in the first collection, while keeping control over ex- 2014 half of 2015 on the back of external demand, penditure growth (at 1.2 percent driven by a Population, million 2.1 inventory accumulation and strengthened double-digit rise in interest payments). Pub- GDP, current US$ billion 49.7 private consumption. The strongest contri- lic debt amounted to 81.9 percent of GDP in bution to growth came from exports March 2015 raising refinancing risks. GDP per capita, current US$ 24205 (growing annually at 5.8 percent), especially Standard and Poor's raised the outlook for Gini Coefficient a 24.4 of motor vehicles. Tourism also contributed Slovenia's 'A-' rating from negative to Life Expectancy at birth, years b 80.3 to growth, while construction decreased by stable, citing improved growth prospects Sources: World Bank, WDI, and M acro Poverty Outlook 3.8 percent as the 2007-13 EU funding peri- and reduced policy uncertainty. For any Notes: (a) Gini data show most recent value (2013). od comes to an end. Employment continued future rating upgrades, focus will need to (b) Life Expectancy data show most recent value (2013). rising in the first six months of 2015 (about remain on sustained fiscal consolidation, one percent on average in 2014-2015), while health care, labor and administration re- unemployment sharply decreased, pushing forms, banking system resolution and the the survey-based unemployment rate down ongoing privatization process. to 9.5 percent in the first half of 2015, about While corporate deleveraging continued Slovenia’s economy continued to grow 0.6 percentage point lower than in the same in 2015, loans to households increased, robustly in the first half of 2015 driven period last year. Both employment and the supporting the recovery in personal con- by exports and inventory accumulation. activity rates (for ages 15+) grew to 51.8 and sumption. The quality of banks’ assets 57.3 percent, respectively. Gross wages rose improved, with non-performing loans The unemployment rate declined to 9.5 in the first half of 2015, mainly due to the amounting to 11.6 percent of the banking percent in the first half of 2015 on the public sector, although public sector em- system’s total exposure in April 2015. back of employment growth. The fiscal ployment declined as part of the consolida- After reaching 7 percent of GDP in 2014, deficit is likely to decline to below 3 per- tion program. Youth unemployment de- the current account surplus slightly wid- clined to 19 percent, while long-term unem- ened in the first half of 2015 due to export cent of GDP in 2015 supported by EU ployment remains stubbornly high at above growth and reduced investment income funds and legislated fiscal rule to reach 56 percent. In 2013, 14.5 percent of the popu- outflows. Net FDI stood at around 1 per- the balanced budget by 2020. The main lation was considered to be living at risk of cent of GDP on a rolling basis. relative poverty with increasing inequality. risks to the outlook come from potential However, for 2014, poverty was estimated delays in undertaking further fiscal con- solidation and growth-enhancing struc- to decline as real per capita income rose and deflationary trends continued throughout Outlook tural reforms amid opposition to public 2015 (prices decreased by 0.5 percent by July). Fiscal consolidation continued in Economic growth is expected to moderate sector reform and privatization. 2015. After reducing the general govern- in 2015-17 to 2 percent. Growth will be ment deficit to 4.9 percent of GDP in 2014 broad-based with exports, investment and FIGURE 1 Slovenia / Contributions to annual GDP growth, FIGURE 2 Slovenia / Unemployment rate, percent percentage points Percent Percent 10 12 5 10 0 8 -5 6 -10 4 -15 2 2007 2008 2009 2010 2011 2012 2013 2014 2015e 0 Final consumption Gross fixed capital formation 2010 2011 2012 2013 2014 2015e 2016f 2017f Change in inventories Net exports Residual item GDP growth Unemployment rate Sources: SORS, World Bank. Sources: SORS, World Bank. MPO 86 Oct 15 88  ●   World Bank ECA Economic Update October 2015 consumption as the main drivers. Recov- with growth in per capita income, is likely nies, while in 21 it aims to retain only the ery in most of Slovenia’s main trading to lead to a further decline in poverty. controlling stake. partners is expected to support exports, Some improvement in measures of shared additionally underpinned by gains in com- prosperity are expected despite the fiscal petitiveness. Private investment is assessed to rise in that period, supported by rein- constraints and measures to revamp the pension system, on the back of labor mar- Challenges vigorated privatization, while after the ket improvements. The government initial slump in 2016, public investment needs to keep spending under control The outlook is subject to downside risks would be benefitting from the new 2014-20 given that Slovenia is scheduled to start around the sovereign debt crisis in the EU financial perspective. Private consump- the gradual implementation of the bal- Eurozone and the still vulnerable and tion is also expected to strengthen on the anced budget rule. Public debt stabiliza- volatile international environment. back of labor market improvement and tion will to a large extent rest on structural While Slovenia enjoys relatively low inter- credit recovery, while government con- reforms tackling pressures from popula- est rates, the annual external financing sumption will contract as the new fiscal tion aging, ongoing commitment to pri- needs over the medium term area stand at rule kicks in. Slovenia needs to ensure a vatization as well as a credible mechanism close to 12 percent of GDP. At the same durable correction of the excessive deficit to reach the medium-term fiscal objective. time, domestically, inconsistency be- in 2015, and achieve fiscal adjustment of The Parliament in July 2015 endorsed the tween the needed fiscal consolidation and 0.6 percent of GDP towards the medium- law on fiscal rule, to be overseen by the public sector awareness creates delays in term objective in 2016. By end-2015, the Fiscal Council as an independent body, reform program implementation. There government must present pension, health with the 2016 effectiveness. The act envis- are diverging opinions on the role of key system and labor market reforms, start ages gradual achievement of the balanced state-owned enterprise, including on their cutting the number of state agencies, and structural budget by 2020. While imple- privatization. Public sector unions rejected revamp the tax system (lower taxation of menting the debt brake after that period, government proposal on the wage policy, labor and increase real estate taxes) to en- the rule allows for exceptions (protecting which aims to extend a ban on hiring and sure that consolidation is sustainable. social transfers, pensions and state institu- promotions until the end of 2016. Further Annual inflation is projected to remain tions) in cases of extraordinary circum- bank and firms restructuring, with overall negative in 2015 due to the decline in glob- stances and recessions. The Parliament ambitious NPL reduction targets, are al commodity prices, trending upwards in also enacted the asset management strate- equally important to reduce the likelihood the following years as domestic demand gy, a blueprint for privatization that re- of a renewed financial stress and the me- strengthens. Unemployment is expected to duced the list of strategic companies and dium-term risk of fiscal support. fall below 9 percent in 2017, which along offers for a full privatization 46 compa- TABLE Slovenia / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices -2.7 -1.1 3.0 2.1 1.8 1.9 Private Consumption -2.5 -4.1 0.7 0.6 1.2 1.5 Government Consumption -2.3 -1.5 -0.1 -1.5 0.1 0.2 Gross Fixed Capital Investment -8.8 1.7 3.2 3.7 0.3 2.1 Exports, Goods and Services 0.6 3.1 5.8 5.0 5.1 4.6 Imports, Goods and Services -3.7 1.7 4.0 3.8 4.0 4.2 Real GDP growth, at constant factor prices -2.4 -0.7 3.8 2.1 1.8 1.9 Agriculture -8.2 -4.3 10.0 2.4 2.6 1.6 Industry -3.6 -1.7 5.5 3.1 2.5 2.2 Services -1.6 -0.2 2.9 1.7 1.5 1.8 Prices Inflation (GDP price deflator) 0.3 0.8 0.8 -0.1 1.5 1.0 Inflation (Consumer Price Index) 2.6 1.8 0.2 -0.2 1.0 1.3 Current Account Balance (% of GDP) 2.6 5.6 7.0 6.9 6.8 6.5 Fiscal Balance (% of GDP) -4.0 -14.9 -4.9 -2.9 -2.8 -2.7 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. In annual percent change unless indicated otherwise. MPO 87 Oct 15 Macro Poverty Outlook Reports ●  89 sures on the somoni have continued to TAJIKISTAN Recent developments mount. The available information sug- gests that the trade deficit narrowed in the first half of 2015 as an 8 percent decline in Economic growth slowed during the first merchandise exports (y/y) was more than half of 2015 as global prices for Tajikistan’s offset by a 25 percent drop in merchan- 2014 key exports—cotton and aluminum— dise imports (y/y). Nevertheless, a steep Population, million 8.4 steadily declined. The worsening external decline in remittance inflows likely wid- GDP, current US$ billion 9.2 environment was exacerbated by the con- ened the current-account deficit in the first GDP per capita, current US$ 1100 traction of the Russian economy, which is half of 2015. Poverty rate (Somoni 158.71/month) a 32.0 both Tajikistan’s main source of remittance Public revenue fell in the first half of 2015 Gini Coefficient b 29.0 inflows and important export market. as the contraction in imports reduced cus- Life Expectancy at birth, years c 67.4 During the first half of 2015 the US dollar toms and VAT revenue. However, a sub- value of remittances fell by 32 percent, stantial increase in direct tax and non-tax Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: year-on-year, curbing domestic demand revenue mitigated the effect on the fiscal (a) M ost recent value (2014). (b) Gini data show most recent value (2014). and suppressing growth in the service balance, which showed a surplus of 1 per- (c) Life Expectancy data show most recent WDI value (2013). sector. Remittances are Tajikistan’s second- cent of GDP in the first half of 2015. The largest source of household income across government cut expenditures while pro- all consumption deciles. High-frequency tecting social programs, which continue to survey data suggest that from early May account for about half of total spending. through mid-July 2015 the real average The external public debt stock fell below Tajikistan’s GDP growth rate is ex- value of remittances dropped by 22 per- 20 percent of GDP at end-June 2015, yet pected to decline from 6.7 percent in cent among households in the bottom 40 Tajikistan’s fiscal stance and debt profile percent of the consumption distribution. remain vulnerable to significant risks 2014 to 4.2 percent in 2015 due to The Tajik somoni has depreciated by 18 stemming from the quasi-fiscal activities negative spillover effects from the Rus- percent against the US dollar since Janu- of state-owned enterprises and weakness- ary 2015. The pass-through effect of the es in the banking sector. sian recession and low prices for Tajik- depreciation pushed the inflation rate The national poverty rate fell from 37.4 istan’s key export commodities. Strong from 5.3 percent to 6.3 percent, year-on- percent in 2012 to 31.6 percent in the first year (y/y), during the first half of 2015. quarter of 2015, but the pace of poverty economic growth helped cut the pov- Concerned about rising inflation rates and reduction has slowed. Between May and erty rate from 37.4 percent in 2012 to their potential impact on social stability July 2015 average real income per capita the central bank has defended the somoni dropped by 23 percent for households in 32 percent in 2014, but sustaining through a combination of interventions the bottom 40 percent of the consumption these gains and achieving further pro- and administrative controls, including distribution. This was primarily due to imposing ceilings on exchange rates set by lower remittance income, and a drop in gress will become increasingly difficult foreign-exchange offices. This policy has the value of remittances was only partial- as the external environment worsens. depleted the country’s already low foreign ly offset by a seasonal increase in the reserves, which stood at about one month number of transfers, as well as a rise in of imports in early July. Meanwhile, pres- agricultural income during the summer FIGURE 1 Tajikistan / GDP growth and contribution to GDP FIGURE 2 Tajikistan / Actual and projected poverty rates growth by sector, 2012-2017 and GDP per capita, 2012-2017 % 40.0 8.0 8.0 7.0 35.0 7.0 6.0 30.0 6.0 5.0 25.0 5.0 4.0 20.0 4.0 3.0 15.0 3.0 2.0 10.0 2.0 1.0 5.0 1.0 0.0 0.0 0.0 2012 2013 2014 2015f 2016f 2017f 2012 2013 2014 2015f 2016f 2017f Poverty rate (TJS 158.71/month) Agriculture Industry Services Net Taxes GDP growth (annual % change) GDP growth (annual % change) Sources: TajStat, World Bank staff calculations. Sources: Source: World Bank (see notes to Table 2). MPO 88 Oct 15 90  ●   World Bank ECA Economic Update October 2015 months. The decline in poverty in recent somoni will continue to put upward pres- worsening external environment on poor years has been driven by real wage sure on the inflation rate, though low inter- households. growth, particularly in the public sector, national food and fuel prices may hold combined with an increase in pension inflation to single digits in 2015. The fiscal payments and strong remittance inflows. However, limited employment creation accounts (excluding externally financed public investment program) are expected Challenges outside the public sector, falling re- to remain roughly balanced over the near mittances and rising prices are now slow- term. However, external-account volatility, As external and domestic pressures contin- ing the rate of poverty reduction. With dwindling foreign-exchange reserves, con- ue to mount the authorities are confronted GDP per capita of less than US$1,100 in tingent liabilities generated by state-owned with the need to strengthen macroeconomic 2014 Tajikistan remains the poorest coun- enterprises and systemic vulnerabilities in management, reinforce resilience against try in the Europe and Central Asia region. the banking sector all pose significant risks external shocks, and implement reforms to to the macroeconomic outlook. boost productivity and competitiveness. Slowing GDP growth is expected to limit The government has already approved an Outlook progress in poverty reduction, but the poverty rate is still projected to fall to 30.7 action plan for 2015-16 designed to address the deteriorating external environment. percent in 2015 and reach 27.3 percent by Policymakers are also formulating new The recession in Russia, combined with 2017. Meanwhile, lower remittances, a medium- and long-term development strat- slowing growth among Tajikistan’s other weaker labor market, and diminished real egies that better reflect the country’s chang- major trading partners, including Turkey, wage growth is expected to slow the ing macroeconomic circumstances. High on Kazakhstan and China, will negatively growth of household purchasing power. the agenda are rebuilding foreign-exchange impact its short-term outlook. However, The poor will likely be negatively affected reserves, addressing financial sector vulner- after decelerating to 4.2 percent in 2015, by both the decline in remittances and abilities, and improving the governance of GDP growth is projected to recover gradu- higher inflation rates, though low interna- state-owned enterprises to minimize fiscal ally in the medium term, though it is ex- tional food and fuel prices will help con- risks and enhance service delivery. Further pected to remain below recent averages. tain consumer price inflation. efforts to facilitate private sector develop- The current-account deficit is projected to A lack of well-targeted social programs ment by improving the business climate improve moderately, narrowing from leaves households vulnerable to economic and advancing the structural reform agenda about 8 percent of GDP in 2014 to 6.3 per- shocks. However, the planned expansion would help Tajikistan sustain economic cent in 2015 and remaining at around 6 of the Targeted Social Assistance Program growth, job creation and poverty reduction percent thereafter. The depreciation of the is expected to mitigate the effects of a despite an adverse external environment. TABLE Tajikistan / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 7.5 7.4 6.7 4.2 4.8 5.5 Private Consumption 8.2 9.1 4.1 -1.2 2.5 3.3 Government Consumption 1.1 1.1 1.1 1.0 1.0 1.0 Gross Fixed Capital Investment 5.3 5.1 6.4 7.7 12.0 6.5 Exports, Goods and Services 5.9 5.5 5.5 3.5 4.5 7.3 Imports, Goods and Services 6.2 5.9 5.9 1.5 5.0 6.5 Real GDP growth, at constant factor prices 7.5 6.7 5.2 4.2 4.8 5.5 Agriculture 10.4 7.6 4.5 4.5 4.7 4.9 Industry 7.7 8.8 6.0 6.3 6.5 6.8 Services 5.8 5.3 5.3 3.1 4.0 5.2 Prices Inflation (GDP price deflator) 12.0 4.9 6.7 11.7 8.5 5.1 Inflation (Consumer Price Index) 5.7 5.0 6.2 8.5 7.5 7.0 Current Account Balance (% of GDP) -2.6 -2.8 -7.9 -6.3 -6.0 -5.9 Fiscal Balance (% of GDP) 0.6 -1.0 -0.5 -1.4 -1.9 -1.8 Poverty Rate a, b, c Poverty rate (Somoni 158.71/month) 37.4 34.3 32.0 30.7 29.1 27.3 Sources: World Bank, M acroeconomics and Fiscal M anagement Global Practice, and Poverty Global Practice. Notes: f = forecast. (a) Calculations based on 2014 HBS. (b) Projection using neutral distribution method (2014) �with pass-through = 0.7 based on GDP per capita constant PPP. (c) Actual data: 2012, 2013, 2014. Projections are from 2015 to 2017. MPO 89 Oct 15 Macro Poverty Outlook Reports ●  91 The rapid rise in food prices elevated in- TURKEY Recent developments flation in the first four months of 2015. Food prices dropped with the new harvest after April, easing the pressure on infla- Surprisingly, Turkish GDP growth tion. However, recently, food prices start- reached 3.4 percent year-on-year in the ed to rise again and the lira continued to 2014 first half of 2015 compared with 2.9 per- depreciate, pushing 12-month inflation up Population, million 76.2 cent in 2014, despite political uncertainty to 7.1 percent by August. GDP, current US$ billion 800.0 in the run-up to the June election. Private Record-high job creation supported pov- GDP per capita, current US$ 10501 consumption lost momentum, partly com- erty reduction in recent years despite a pensated by higher public spending. Net slow-down in growth. However, job crea- Poverty rate($2.5/day 2005PPP terms) a 4.5 exports, which contributed positively to tion slowed in the first half of 2015, and Poverty rate($5/day 2005PPP terms) a 20.7 b GDP in the first quarter because of gold unemployment rate inched up to 10.5 per- Gini Coefficient 40.0 c exports and a slump in imports, became a cent in June 2015, which is above the pre- Life Expectancy at birth, years 74.9 drag on growth with weak export de- crisis level. Unemployment is also becom- Sources: World Bank, WDI, and M acro Poverty Outlook. Notes: mand. However, private investment ing more long-term with about one third (a) M ost recent value (2012). (b) Gini data show most recent WDI value (2011). surged by 7.8 percent q-o-q in the second of job seekers looking for a job for more (c) Life Expectancy data show most recent WDI value (2013). quarter, which indicates that the private than six months. Moreover, labor force sector front-loaded investment spending participation rate remains low at 51.4 per- before the June elections, anticipating cent as of June 2015. Among the employed, elimination of political uncertainties after informal employment remains high, and Economic growth surprised positively the election. the pace at which it was declining slowed The hoped-for external adjustment fueled considerably, especially among male with 3.4 percent year-on-year in the first by a weaker lira and significantly lower workers. These factors constrain poverty half of 2015, up from 2.9 percent in 2014, oil prices has not materialized because of reduction and shared prosperity in Tur- despite political uncertainty in the run-up disappointing global demand. Turkey`s 12 key. Also, the elevated food inflation has to the June parliamentary election. The -month rolling gold-adjusted current ac- affected low-income groups disproportion- count deficit widened to $45 billion (5.8 ately, because food composes a higher election resulted in a hung parliament. percent of GDP) in July 2015. fraction of their consumption basket. With another election scheduled for No- Domestic political concerns and global The contribution of sectoral shifts in em- vember 1, 2015, uncertainties continue, financial market jitters reduced financial ployment from agriculture to the other inflows in the first seven months of 2015. A sectors, which was a significant factor in while escalating tensions in Turkey’s drawdown of foreign exchange reserves poverty reduction in the pre-crisis period, South East and a weak international envi- by $2.5 billion financed some of the current weakened recently. In particular, the share ronment weigh on growth and poverty. account deficit, with the unrecorded trans- of non-agricultural employment increased Medium-term prospects depend on the actions amounting to a positive $9.1 billion by only 0.5 percent y-o-y in the second in this period. The Turkish lira depreciated quarter of this year as a result of recent resolution of political uncertainty and the by 31 percent against the US dollar and 23 slowdown in job creation. The regional restoration of investor confidence. percent against the euro between January disparities on the other hand continued to and mid-September 2015. diminish, narrowing down the gap be- FIGURE 1 Turkey / Contributions to annual GDP growth FIGURE 2 Turkey / Actual and projected poverty rates and real GDP per capita, 2000-2017 Contributions to Growth 60 25,000 15% 50 10% 20,000 5% 40 Poverty Rate (%) GDP per capita 15,000 0% 30 10,000 -5% 20 -10% 5,000 10 -15% 1999 2001 2003 2005 2007 2009 2011 2013 0 - 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 C I G Stocks NX GDP $2.5/day PPP $5/day PPP GDP per capita Source: TurkStat. Source.: World Bank (see notes to Table 2). MPO 90 Oct 15 92  ●   World Bank ECA Economic Update October 2015 tween the highest and lowest employment the backdrop of continued political uncer- nesses in the labor market are likely to rates among regions to 15 percent in the tainty. The renewed currency depreciation continue in the medium-term, which im- end of last year which was 29 percent in the and stubbornly high inflation are likely to ply relatively flat patterns for our poverty pre-crisis period. Reflecting all these fac- decrease the purchasing power of house- projections in the medium-term. The $5 tors, 18.8 percent and 3.7 percent of popula- holds and worsen their financial situation. and $2.5 a day PPP poverty rates are ex- tion fell below $5 and $2.5 a day PPP pov- Hence, we expect private consumption to pected to decline gradually to 17.3 percent erty lines in Turkey in 2014, respectively. slow significantly in the remainder of the and 3.3 percent by 2016, respectively. year. In addition, continuing political un- certainty and escalating tensions in Tur- Outlook key’s South East make it difficult for the private sector to sustain the investment Challenges spending witnessed in the second quarter. The Justice and Development Party (AKP) Businesses are likely to cut investment Restoring investor confidence is key to won 41 percent of the votes and the most spending from the second quarter and growth over the short to medium term. seats (258 of 550) in parliament in the elec- postpone investment decisions until a new Private investment has been weak for the tion held on June 7, 2015. However it fell stable political equilibrium is reached. On last three years. Investor sentiment heavi- short of the absolute majority it had held the external side, although the nascent re- ly depends on how the political process since 2002. Coalition discussions ended covery in the EU is expected to support resolves. Structural reforms were on the without success at the end of the 45-day exports, the economic difficulties in MENA political back-burner throughout the re- deadline given in the constitution, paving and Russia are likely to restrain export cent electoral cycle, although the authori- the way for a snap election on November growth in 2015. External adjustment should ties had been preparing to re -launch 1. Opinion polls show that the new elec- continue, as lower oil prices will likely re- structural reforms after the elections. Es- tion will probably result in a small gain in duce the current account deficit by another calating tensions in the poorest region of votes for AKP, but that it would still fall $5 billion in the remainder of the year. Turkey and uncertainty around migration short of the majority needed to form a We see GDP growth reaching 3.2 percent influx from neighboring countries might single-party government. Deep divisions in 2015, with the current account deficit pose a challenge going forward in terms between the political parties would then stabilizing at 5.5 percent of GDP and infla- of poverty reduction. There is an urgent still make the formation of a government a tion reaching 7.5 percent. The outlook for need for a stable, inclusive government difficult task. 2016 depends on the resolution of the po- and the return to implementation of the Economic activity is expected to slow litical uncertainty in Turkey after the No- structural reform agenda to restore inves- sharply in the second half of 2015 against vember 1 parliamentary elections. Weak- tor confidence. TABLE Turkey / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 2.1 4.2 2.9 3.2 3.5 3.5 Private Consumption -0.5 5.1 1.4 3.9 4.2 4.4 Government Consumption 6.1 6.5 4.7 7.9 2.4 2.3 Gross Fixed Capital Investment -2.7 4.4 -1.3 2.8 2.5 2.5 Exports, Goods and Services 16.3 -0.2 6.8 0.3 2.4 2.5 Imports, Goods and Services -0.4 9.0 -0.2 3.4 3.0 3.3 Real GDP growth, at constant factor prices 2.2 4.1 2.9 3.2 3.5 3.5 Agriculture 3.1 3.5 -1.1 2.0 2.0 2.0 Industry 1.6 4.0 1.5 1.6 1.6 1.6 Services 2.4 4.3 4.5 4.4 4.9 4.8 Prices Inflation (GDP price deflator) 6.9 6.2 8.5 10.6 9.2 8.7 Inflation (Consumer Price Index) 8.9 7.5 8.9 7.5 6.8 6.5 Current Account Balance (% of GDP) -6.2 -7.9 -5.8 -5.5 -5.7 -5.8 Fiscal Balance (% of GDP) -1.4 -1.6 -2.0 -2.4 -1.9 -1.6 a, b, c Poverty Rate Poverty rate ($2.5/day 2005 PPP terms) 4.5 4.0 3.7 3.5 3.3 3.1 Poverty rate ($5/day 2005 PPP terms) 20.7 19.6 18.8 18.0 17.2 16.5 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 201 2-HICE. (b) P ro jectio n using neutral distributio n (201 with pass-thro ugh = 1 based o n GDP per capita co nstant P P P . 2)� (c) A ctual data: 201 2. Data fo r 2013-4 are estimates, data fro m 2015 thro ugh 2017 are pro jectio ns. MPO 91 Oct 15 Macro Poverty Outlook Reports ●  93 cation, public administration, and defense UKRAINE Recent developments (which employ approximately 28 percent of those employed among the bottom 40 percent in the income distribution). All Real GDP dropped about 16 percent y/y in these factors combined led to an increase the first half of 2015, and the decline is in the moderate poverty rate from 3.2 per- 2014 broad based across all sectors. Industrial cent in 2013 to 5 percent in 2014. Population, million 45.2 activity contracted 20.5 percent y/y, led by GDP, current US$ billion 131.8 sharp declines in eastern regions. Curren- GDP per capita, current US$ 2916 cy depreciation and a one-off utility-tariff Outlook Poverty rate ($2.5/day 2005 PPP terms) a 0.1 adjustment accelerated inflation, which Poverty rate ($5/day 2005 PPP terms) a 3.2 peaked at 60.9 percent y/y in April and Gini Coefficient b 24.6 declined to 52.8 percent y/y in August. Despite early signs of stabilization, eco- Life Expectancy at birth, years c 70.9 Meanwhile, fiscal consolidation stabilized nomic prospects for Ukraine depend on Sources: World Bank, WDI, and M acro Poverty Outlook. the general government headline deficit how the conflict in the east unfolds and Notes: outperforming the IMF program target. whether the authorities are able to sustain (a) M ost recent value (2013). (b) Gini data show most recent WDI value (2013). After a sharp depreciation in early 2015 reforms. Real GDP is projected to contract (c) Life Expectancy data show most recent WDI value (2013). followed by administrative restrictions on by 12 percent in 2015, with sharp declines imports, the current account is nearly bal- in metals and mining due to the conflict anced since April. Net capital outflows and weakening external demand. Curren- persisted, driven mainly by external debt cy depreciation would support net exports An unfavorable global economic envi- payments in excess of official financing and a gas tariff increase coupled with im- ronment and the conflict in the east led flows. This helped to rebuild international proved spending efficiency should create reserves that cover 3 months of imports as fiscal space to unlock government invest- to a larger than earlier projected decline of beginning of September. ment going forward. In addition, contin- in real GDP in the first half of 2015 Against the backdrop of negative growth ued resolution of problems in the banking with increasing poverty and unemploy- and high inflation, real wages and pen- system could permit gradual resumption sions have declined, thus reversing gains of lending. These factors, along with a low ment. Despite a few encouraging signs made earlier in income levels, particularly statistical base, are expected to set the of stabilization, Ukraine’s economic pro- among the less-well off. This decline was stage for a modest economic recovery, spects are a subject to high risks. We only partially offset by social-assistance with real GDP growing 1 percent in 2016 project GDP to decline by 12 percent in reforms aimed at better targeting existing and 2 percent in 2017. benefits, while deteriorating labor -market The general government deficit is project- 2015 and to recover only gradually conditions aggravated these trends. In Q1 ed to decline from 4.2 percent of GDP in starting from 2016. The large decline in the unemployment rate increased to 9.6 2015 to 3.1 percent of GDP in 2017. The output in 2015 is likely to lead to a pov- percent (from 9.0 percent a year earlier) gas tariff increase is expected to help re- and real wages declined by 21 percent. duce the below-the-line financing require- erty increase by 5.2 percentage points, This decline is uneven across sectors, with ments stemming from the Naftogaz deficit equivalent to 2.3 million people in 2015. the lowest nominal-wage growth in the by 2016. Macroeconomic adjustment public sector, particularly in health, edu- should help to keep current-account defi- FIGURE 1 Ukraine / Contributions to GDP growth, FIGURE 2 Ukraine / Actual and projected poverty rates, percent 2008-2017 10 15 5 8 -5 6 -15 4 -25 2 -35 2008 2009 2010 2011 2012 2013 2014 2000 2001 2002 2003 2004 2005 2006 2007 2015 2016 2017 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Residual item Net Exports Gross Fixed Investment Extreme poverty rate ($2.5 day PPP terms) Household Consumption Public consumtion Changes in inventories Extreme poverty rate projections Real GDP Growth Moderate poverty rate ($5 day PPP terms) Moderate poverty rate projections Sources: Ukraine State Statistic Service, World Bank. Sources: World Bank (see notes to Table 2). MPO 92 Oct 15 94  ●   World Bank ECA Economic Update October 2015 cit relatively low. Financial pressures as- minimum wage, transfers, and pensions confidence and destroy industrial potential, sociated with net capital outflows would are anchored has been frozen for two ii) global commodity prices decline that also ease, in view of the restructuring of years. Pension cuts and further tariff in- negatively impacts Ukraine’s terms of sovereign and quasi-sovereign debt, the creases, together with high inflation, are trade, iii) slowdown in reforms that may ongoing restructuring of foreign liabilities likely to erode the purchasing power of increase structural imbalances again and by private-sector companies, and an in- households throughout the whole distri- delay the official financial assistance. The crease in FDI related to bank recapitaliza- bution, but particularly among the poor government’s capacity to mitigate the se- tion. If expectations concerning modest and the bottom 40 percent. Besides, the vere impacts of the ongoing recession on economic recovery, gradual currency sta- conflict will continue affecting employ- the poor is likely to be limited in a fiscally bilization, and sustained fiscal discipline ment. Despite some modest signs of in- constrained environment with multiple are fulfilled, the public and publicly- dustrial production restarted in June 2015, demands, even though such measures are guaranteed debt would decline to 82 per- the situation remains volatile. In addition, crucial for the sustainability of the reforms. cent of GDP by 2017. internally displaced people remain the In sum, a fragile political environment, The moderate poverty rate is expected to most vulnerable groups and those most geopolitical challenges, possible social re- double to 10.2 percent in 2015. And even if dependent on public transfers, while their sistance to reforms in the absence of strong the modest recovery materializes in 2016 host communities struggle to absorb them, safety nets, opposition by vested interests and 2017, it would remain above its 2014 create jobs, and provide services. who stand to lose from reforms, declining levels. Poverty trends are likely to be most terms of trade, and sharper contraction in influenced by the ongoing fiscal adjust- global demand – all these factors could ment and the conflict in the east. The fiscal adjustment would continue affecting neg- Challenges undermine reforms and exacerbate fiscal and balance of payment problems. To miti- atively wage and employment dynamics, gate a vast array of risks confronting especially in the public sector, and con- The outlook is subject to serious downside Ukraine, it is important for the authorities tributes directly to social vulnerability, as risks: i) escalation of the conflict that may to remain committed to continuing macroe- the subsistence minimum to which the further jeopardize investor and consumer conomic and structural reforms. TABLE Ukraine / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 0.2 0.0 -6.8 -12.0 1.0 2.0 Private Consumption 8.4 6.9 -9.6 -18.6 -1.5 0.0 Government Consumption 4.5 -0.9 0.6 -5.0 5.0 7.0 Gross Fixed Capital Investment 5.0 -8.4 -23.0 -24.8 10.7 17.3 Exports, Goods and Services -5.6 -8.1 -14.5 -19.8 6.0 5.0 Imports, Goods and Services 3.8 -3.5 -22.1 -31.7 3.1 6.5 Real GDP growth, at constant factor prices 0.2 -0.2 -5.7 -12.0 1.0 2.1 Agriculture -4.3 13.8 3.0 -10.0 0.0 1.5 Industry -1.8 -8.0 -20.0 -17.0 1.4 2.8 Services 2.9 1.0 -0.1 -10.3 1.1 2.0 Prices Inflation (GDP price deflator) 7.8 4.3 14.7 41.5 20.0 10.0 Inflation (Consumer Price Index) 0.6 -0.3 12.1 36.4 4.0 4.0 Current Account Balance (% of GDP) -8.2 -9.0 -5.3 -1.0 -1.3 -1.6 Fiscal Balance (% of GDP) -3.3 -3.7 -4.7 -3.9 -3.3 -1.1 a, b, c Poverty Rate Poverty rate ($2.5/day 2005PPP terms) 0.1 0.1 0.1 0.3 0.2 0.1 Poverty rate ($5/day 2005PPP terms) 3.9 3.2 4.9 9.7 8.6 6.8 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No tes: f = fo recast. (a) Calculatio ns based o n ECA P OV harmo nizatio n, using 2009-HLCS and 201 3-HLCS. (b) P ro jectio n using A nnualized elasticity (2009-201 with pass-thro ugh = 1based o n GDP per capita co nstant P P P . 3) � (c) A ctual rates fo r 2012-2013; 2014 is an estimate and 201 5-2017 are pro jectio ns. MPO 93 Oct 15 Macro Poverty Outlook Reports ●  95 Kazakh tenge, and the Chinese yuan, and UZBEKISTAN Recent developments (b) government’s efforts to contain domes- tic inflation and to support priority indus- trial sectors. For that purpose government Uzbekistan’s GDP grew at 8.1 percent in kept official exchange rate depreciation at 2014, overcoming headwinds from the a much lower rate than the currency de- 2014 external environment and aided by coun- preciations of the main trading partners. ter cyclical fiscal policies and measures to Poverty declined from reportedly 14.1 Population, (mid-year) mln 30.8 expand credit to the private sector. In the percent in 2013 and to an estimated 13.7 GDP, US$, bn 62.7 first half of 2015, the economic difficulties percent in 2014-15, according to the offi- GDP per Capita, US$ 2,038 in Russia (one of Uzbekistan’s largest cial statistics and the official poverty line. Poverty rate, official1 13.7 Gini coefficient, (2013)2 0.29 trading partners) persisted, as did govern- The drop in poverty reflects rapid per Life expectancy at birth3 68.2 ment’s response continuing and strength- capita economic growth, sustained annual School enrolment rate, in general 99.8 ening the policies initiated in 2014. As a increases in salaries, incomes from micro result, GDP grew at 8.1 percent in the first and small businesses (MSEs), and the gov- Notes and Sources: 1/ Official poverty line is minimum food consumption equivalent half of 2015. ernment’s targeted support programs. to 2,100 kilocalories per person per day; On the demand side, growth was driven by Over the years, stable net remittances 2/ Uzbekistan: Millennium Development Goals Report - Tash- kent, UN, 2015, p.19; a strong increase in investment and a more from labor migrants at around 6 percent 3/ Life expectancy: UN statistics, and 73 by national stat. moderate increase in consumption, bol- of GDP on average have helped many stered by tax rate cuts on businesses and families in Uzbekistan to keep poverty at personal incomes and a 17 percent nominal bay. The distribution of income has be- increase in wages of civil servants and SOE come more equitable over time, as indicat- GDP growth in 2015 is projected to slow employees. On the supply side, the first ed by the Gini coefficient (income) that fell to 7 percent due to a weaker external en- half of 2015 saw a very significant jump in from 0.39 in 2001 to 0.29 in 2013. vironment, including further declining construction services (18 percent yoy), but also significant growth in services (13.1 world prices of key commodities. While counter cyclical fiscal policy is expected to percent yoy), agriculture 6.5 percent (yoy) and industry (by 5.8 percent). Outlook continue, and to help bolster economic The weakened external environment led Uzbekistan’s external account to weaken Economic growth is projected to slow to 7 growth, returning migrants will create as the exports to Russia and other trading percent in 2015. Two external factors are pressures for additional good jobs. The partners (excl. China) declined in the face expected to influence the performance of of lower growth, declining commodity the Uzbek economy in 2015 and 2016-17. sustainable response to these pressures is prices, and an appreciating som. Im- First is the weak economic performance in accelerated structural reforms that lead to portantly, Uzbekistan’s remittances, the country’s main trading partners increases in productivity. The rapid de- which came to about 9 percent of GDP in (Russia, China, Kazakhstan, Turkey and 2014 declined by 48 percent in the first Korea,) and, second, lower prices of Uz- cline in the official poverty rate of recent half of 2015. bekistan’s key export commodities -- gas, years is expected to slow in 2015-17. The som appreciated as a result of the (a) copper, cotton, and gold. These factors are depreciations of the Russian ruble, the expected to lead to exports dropping by FIGURE 1 Uzbekistan / Sector Contributions to GDP Growth, FIGURE 2 Uzbekistan / Official and Subjective Poverty 2001–15 (%) Rates Percent % of 10.0 9.5 pupulation in 9.0 poverty 9.0 0.5 8.5 8.3 8.1 8.2 8.0 8.1 8.0 7.7 1.6 0.8 0.6 0.6 30 0.5 0.6 0.6 0.6 7.0 25.4 7.0 7.3 1.5 1.0 0.8 24.9 7.0 1.0 0.6 1.3 1.0 1.1 25 1.5 1.4 0.7 6.0 0.9 1.0 1.4 0.9 1.0 1.2 1.2 1.2 0.7 17.7 0.9 0.5 20 16.9 0.9 0.5 0.5 1.2 1.2 1.0 5.0 4.5 0.7 4.2 4.4 2.7 1.5 2.5 15 4.0 0.6 0.3 0.4 1.6 1.0 1.2 1.2 0.3 0.5 0.4 0.4 0.7 10 3.0 1.4 1.7 0.2 5.2 5.3 5.2 5.3 1.9 4.7 5 2.0 0.2 0.2 3.8 3.7 3.4 0.2 2.9 3.2 3.2 3.2 1.0 2.0 0 1.4 1.8 2006 2010 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015* Services Construction Agriculture Subjective/LITS Objective/GOU Sources: Uzbek authorities, World Bank. Sources: EBRD Life in Transition Survey (LITS) 2006 and 2010 on subjective Poverty (defined as falling into the bottom 1/3 of the income distribution) and results of Government of Uzbekistan (GOU) household budget surveys. MPO 94 Oct 15 96  ●   World Bank ECA Economic Update October 2015 6.7 percent, and remittances dropping by With the continuation of fiscal policies to migrants and the widening gap between 55 percent in 2015. Imports are also ex- reduce the tax burden, the consolidated state those with jobs and those without. pected to decline due to slower growth in budget surplus is expected to reach 0.8 per- To strengthen competiveness and to create industry and tighter control over access to cent of GDP in 2015, down from 1.6 percent more good jobs that absorb returning mi- foreign exchange. In turn, the external of GDP in 2014. The present scenario does grants and those entering the labor force, current account surplus is expected to not include any significant changes in mone- structural reforms to encourage private drop to 0.2 percent of GDP in 2015, from tary or exchange rate polices. investment are needed. The authorities 1.3 percent in 2014. continue to advocate a slow transition to a To counter the adverse external environ- more market-oriented economy; yet a ment, the government is expected to support consumption and investment through in- Challenges more ambitious structural reform agenda to create space for more private sector in- creased public investment for the newly vestment is now becoming more important adopted industrial and infrastructure devel- Given weaker income growth and larger given the deterioration in the external de- opment program for 2015–19; increased gov- inflow of returning migrants in 2015, no mand environment. These reforms can ernment spending raising minimum wages, progress is expected in the near term to comprise, improving the business environ- pensions, and social payments to maintain reduce unemployment, poverty or ine- ment and governance to reduce cost of incomes in 2015; additional production and quality. National poverty (an equivalent trade and finance, further reducing taxes exports of foodstuffs and gold to ensure total of extreme poverty) is expected to remain on firms and individuals, and increasing export growth in 2015; allocation of addition- at 13.7 percent in 2015 and decline only incentives for private investors and SOEs al credit to small firms and making further slowly in 2016-17. Inequality (as measured to adopt technologies and for employees to marginal improvements to the business envi- by the Gini coefficient) is projected to re- increase productivity. ronment to create jobs, including for return- main unchanged by 2017, reflecting rela- ing labor migrants. tively weaker income growth of returning TABLE Uzbekistan / Macroeconomic outlook indicators (annual percent change unless indicated otherwise) 2012 2013 2014 2015 f 2016 f 2017 f Real GDP growth, at constant market prices 8.2 8.0 8.1 7.0 7.5 7.7 Private Consumption 5.7 6.0 5.1 4.7 5.2 5.5 Government Consumption 8.0 9.2 13.1 9.2 6.5 6.2 Gross Fixed Capital Investment -0.3 7.9 17.7 9.0 6.5 7.6 Exports, Goods and Services -4.0 10.9 -4.1 -6.7 3.1 8.9 Imports, Goods and Services 9.0 4.4 5.7 -3.6 -1.2 4.2 Real GDP growth, at constant factor prices 8.3 9.9 8.8 6.9 7.4 8.0 Agriculture 7.0 6.8 6.9 6.0 6.7 6.8 Industry 4.4 6.0 5.7 3.0 4.0 4.5 Services 10.5 13.0 10.8 8.6 8.8 9.5 Prices Inflation (GDP price deflator) 17.9 13.1 12.1 11.0 10.2 10.2 Inflation (Private Consumption Deflator) 22.9 13.0 12.0 10.0 10.0 10.0 Current Account Balance (% of GDP) 1.2 0.8 1.2 0.2 0.3 0.4 Fiscal Balance (% of GDP) 5.3 3.5 1.6 0.8 1.2 1.7 So urces: Wo rld B ank, M acro eco no mics and Fiscal M anagement Glo bal P ractice, and P o verty Glo bal P ractice. No te: f = fo recast. MPO 95 Oct 15 y Prices and Weak Currencies Low Commodity Europe and Central Asia Economic Update Office of the Regional Chief Economist October 2015 Against the backdrop of a weakening global economy and volatility in international financial markets, countries of the Europe and Central Asia region (ECA) are transitioning to a new normal. Oil-exporting countries in eastern part of ECA face the difficult adjustment to low commodity prices. Faster and more effective insolvency procedures, strengthened financial sectors, and higher absorption of European Union (E.U.) structural funds can contribute to rebound. This economic update consists of two parts: (i) economic outlook, comprising two chapters, and (ii) country pages. In part one, the first chapter describes the outlook for gross domestic product (GDP) growth, and then goes beyond GDP in a couple of important areas. It shows that terms-of-trade losses for oil exporters this year are much larger than changes in GDP. The second chapter establishes the link between oil prices and real exchange rates, both theoretically and empirically. Part two contains 26 two-page macro poverty outlook reports for ECA countries. ISBN (electronic): 978-1-4648-0753-4 2015 International Bank for Reconstruction and Development / The World Bank Some rights reserved 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org