83136 Report No. 83136-ECA South East Europe Regular Economic Report No.5 Slow Road to Recovery December 9, 2013   Acknowledgments This Regular Economic Report (RER) covers economic developments, prospects, and policies in six South Eastern European countries (SEE6): Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. The report is produced twice a year by staff of economists at the World Bank Europe and Central Asia Region Poverty Reduction and Economic Management Department (ECA PREM). The team of authors is led by Gallina Andronova Vincelette, Željko Bogetić, and Abebe Adugna; the following team members have thematic and/or country assignments: Simon Davies (fiscal and debt; and Bosnia and Herzegovina); Agim Demukaj (external sector; and Kosovo); Doerte Doemeland, Nikola Kojucharov, and Ivan Kusen (labor market; monetary policy; inflation developments); Raquel Letelier (financial sector); Anil Onal (database management; and Albania); Lazar Sestović (real sector; and Serbia); Sanja Madzarević-Sujster (Montenegro); Bojan Shimbov (financial sector, FYR Macedonia), Ekaterine Vashakmadze and Mizuho Kida (global developments and outlook); Maria Andreina Clower, Christopher Pala, and Budy Wirasmo provided invaluable assistance in editing and designing this report. Dissemination of the report as well as external and media relations is managed by Lundrim Aliu, Anita Bozinovska, Ana Gjokutaj, Jasmina Hadzić, Andrew Kircher, Vesna Kostić, Sanja Tanic; Boris Balabanov, Mirjana Popovć, John Mackedon, Kristyn Schrader-King, and Dragana Varezić. The team is grateful to Ellen Goldstein (Country Director, South Eastern Europe), Roumeen Islam (Acting Sector Director, ECA PREM), Satu Kähkönen (Sector Manager, ECA PREM),and the South East Europe Country Management Unit for their guidance in the preparation of this report. The team is thankful for comments on earlier drafts of this report received from Central Banks and Ministries of Finance in the SEE6 countries. This and previous SEE RERs may be found at: www.worldbank.org/eca/seerer Standard Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Copyright Statement: The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. 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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Contents Summary1 Chapter 1: Recent Macroeconomic Developments 5 Modest Growth after the Double-Dip Recession 5 Continued Improvements in Trade and External Debt 9 Nascent Employment Gains 11 Disinflation13 Depressed Credit Growth 15 Persistent Fiscal Pressures  21 Chapter 2: Macroeconomic Outlook 27 Weak Growth Ahead 27 From Weak to Robust Growth: Improving Productivity and Competitiveness 28 Improved Business Climate, but Further Reforms Needed 29 Annex: Macroeconomic Indicators 32 List of Figures Figure 1: Economic Growth Rates in SEE6 5 Figure 2: Growth of Industrial Output in 2013 6 Figure 3: Global Industrial Production and Trade: Recovering 7 Figure 4: Borrowing Costs in Select European Countries: Moderating 7 Figure 5: SEE Labor Productivity in SEE vs. EU11 and EU15 8 Figure 6: Labor Productivity in the SEE 8 Figure 7: Real Unit Labor Costs 9 Figure 8: Contributions to Change in Unit Labor Costs Since 2008 9 Figure 9: SEE6 Combined Current Account and Trade Balances 10 Figure 10: SEE6 Countries’ Half Year Current Account Balance 10 iv  | Contents SLOW ROAD TO RECOVERY Figure 11: SEE6 Export Growth 10 Figure 12: Worker Remittances 2010–H1 2013 10 Figure 13: Average SEE6 External Debt 11 Figure 14: Total Public and Private External Debt 2010–H1 2013 11 Figure 15: Employment in Regional Context 12 Figure 16: SEE: Paths of Employment Recovery 12 Figure 17: Sectoral Drivers of Employment Recoveries 12 Figure 18: Unemployment Rates 2013 13 Figure 19: Unemployment Rates in Regional Context 13 Figure 20: CPI inflation 14 Figure 21: Food Price Inflation 14 Figure 22: Energy Price Inflation in SEE6 14 Figure 23: Regional CPI Inflation Comparison 14 Figure 24: Output Gaps in SEE6* 15 Figure 25: Official Policy Rates 15 Figure 26: Real Broad Money Supply 15 Figure 27: Funding and Funding Costs for SEE6 Countries 16 Figure 28: CDS Spreads of SEE countries 16 Figure 29: Non-performing Loans 17 Figure 30: Asset Quality of Loan Portfolio, December 2012 17 Figure 31: Loan-to-Deposit Ratios 20 Figure 32: Capital Adequacy Ratio 20 Figure 33: Liquidity Ratio 20 Figure 34: Credit Growth Rates 21 Figure 35: Average Structural Fiscal Balance and Economic Growth 22 Figure 36: Structural Fiscal Balances 22 Figure 37: Fiscal Deficits 22 Figure 38: Contribution Toward Change in Deficits, 2012–13 22 Figure 39: Public Expenditure 23 Figure 40: Contribution Toward Change in Spending, 2009–12 23 Figure 41: Wage Bill and Social Benefit Spending, 2012 23 Figure 42: Benefits Coverage of Households 24 Figure 43: Benefits to Top and Bottom Quintiles Households 24 Figure 44: General Government Debt without Guarantees 24 Figure 45: State Guarantees  24 Figure 46: Distance to Frontier on the Ease of Doing Business, 2009–13 30 Figure 47: SEE6 Distance to the Frontier in the Areas of Doing Business, 2009 vs. 2013 30 Contents  |  v SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 List of Tables Table 1: Growth of Goods Exports 6 Table 2: Asset Shares of Foreign Banks in SEE6, 2012 16 Table 3: Economic Growth Rates 2012–14 27 List of Boxes Box 1: External Developments in 2013  7 Box 2: NPL Resolution Efforts in SEE6: The Experience to Date 18 Box 3: Implications of Croatia’s EU Accession for SEE6 29 vi  | Contents SLOW ROAD TO RECOVERY Summary Recent Economic Developments economic growth will be too weak to support substantial gains in employment. The South East Europe (SEE6) region exited from recession in the first half of 2013, As export performance strengthened and supported by a nascent recovery in the Euro imports declined, current account balances area. Industry––especially manufacturing narrowed. The gradual recovery in the Euro exports and energy––drove the recovery. The Area helped the combined (weighted average) region experienced a welcome surge in exports goods exports of SEE6 to grow by close to in 2013, particularly car exports from Serbia. 13 percent (year-on-year), making a strong Favorable weather conditions supported a positive contribution to overall economic strong contribution of agricultural output growth. Export growth picked up everywhere, to economic growth and helped weaken propelled by new foreign direct investment inflationary pressures. However, domestic (FDI)-based export capacity. However, the demand remained depressed in most of the sustainability of this high export growth is region, reflecting high unemployment, sluggish uncertain in view of the region’s narrow export growth of household incomes and credit, and base and competitiveness issues. Weak domestic a difficult investment climate. Only in Kosovo demand depressed imports in all countries but and FYR Macedonia did public investment Serbia, where their rise was led by raw materials contribute to some strengthening of domestic and parts used in export-oriented industries. demand. Beyond these short-term factors, a FDI remained sluggish in SEE6, rising only by slowdown in productivity growth and rising 0.7 percent of gross domestic product (GDP), unit labor costs adversely affected economic but its share of financing of the current account growth, lowering competitiveness and demand increased. Remittances continued to be resilient for labor. overall, but the Greek crisis began to take its toll, especially on Albania. Unemployment in the region, at about 24 percent on average1, began to decline in the Foreign banks’ deleveraging from SEE6, rising first half of 2013 from its peak crisis levels. While non-performing loans (NPLs) and weak credit employment grew in Albania, FYR Macedonia growth underpinned the need for vigorous and Montenegro, it remained depressed in reforms to reduce vulnerabilities in the financial Serbia and Bosnia and Herzegovina. But even sector. European banks continued to deleverage where employment has recovered meaningfully and reduced their exposure to the SEE6 region. since 2010, the gains were not broad-based With the aim of improving their resilience and mostly concentrated in services Near-term and supervisory capacity, the SEE6 countries made some progress in implementing banking reforms over the past year. Banks remained 1 All SEE6 region-wide average aggregates are simple averages unless specifically noted otherwise. well-capitalized with actual capital-adequacy Summary  |  1 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 ratios above the regulators’ requirements 9 percent of GDP) and the poorly targeted in all six countries. Liquidity was high at social transfers (at 12.5 percent of GDP on 25–35 percent of total assets. However, NPLs average). As a result, the pace of the fiscal reached worrisome levels at above 20 percent adjustment remained insufficient to reverse of total loans in Albania and Serbia and about the adverse debt dynamics in some countries. 18 percent in Montenegro. Their rise stemmed Average public debt increased in SEE6 and is from the sluggish state of the economy, weak expected to reach 45 percent of GDP by end- insolvency regimes and widespread payment 2013, from 42 percent a year earlier. Public indiscipline in the private sector, exacerbated debt remained at above 60 percent of GDP in by public sector arrears to businesses in some Albania, Montenegro, and Serbia. of the SEE6 countries. In this environment, despite ample liquidity and cuts in policy rates, banks remained reluctant to extend new loans. Growth Outlook and Risks As a result, credit growth slowed in most SEE6 countries. With depressed domestic demand, uncertain export prospects, and significant external risks, Fiscal deficits remained high and public debt the SEE6 short-term outlook remains frail. increased in 2013. The SEE6 average fiscal After the bounce-back of the regional economy deficit is expected to remain at elevated levels in the first half of 2013 and taking into account at 4.2 percent of GDP in 2013 (compared the latest high-frequency data, economic growth to 4.1 percent of GDP in 2012). Structural for the year is expected be around 1.8 percent. rigidities in public expenditures, the weak tax Net exports will continue to drive growth in base, and depressed fiscal revenues contributed SEE6 in the short term. However, given the to this outcome. Despite some fiscal limited export base of the SEE6 economies and consolidation efforts, the SEE6 governments the uncertain new FDI-driven export capacity, did not address key rigidities such as the sustained export-led recovery is by no means high public sector wage bill (averaging over assured. Much depends on a lasting recovery of external demand. In contrast, unfavorable Economic Growth Rates, 2012–2014  labor market conditions, a poor investment 2012 2013f 2014f climate, and difficult credit conditions that depress consumption and investment will Albania 1.6 1.3 2.1 keep a lid on the overall economic activity. Bosnia and Herzegovina -1.1 0.8 2.0 Therefore, weighted real GDP of the SEE6 Kosovo 2.7 3.0 4.0 region is now expected to grow 1.8 percent in FYR Macedonia -0.4 2.5 3.0 2014, about one percentage point less than the Montenegro -2.5 1.8 2.5 earlier, mid-2013 estimate. The slowdown is Serbia -1.7 2.0 1.0 driven by the Serbian economy, which is now SEE6* -0.7 1.8 1.8 expected to expand by only 1 percent in 2014 Memo item: (compared to a 2 percent mid-2013 estimate) Euro Area -0.6 -0.4 1.1 because of the planned fiscal consolidation and Source: World Bank staff projections. Note: Weighted average. a declining private consumption. In contrast 2  | Summary SLOW ROAD TO RECOVERY to Serbia, economic growth in the other five now enjoy dynamic, open, and export-oriented SEE countries is expected to firm up in 2014 economies with large FDI and associated and exceed the pace of economic expansion of transfer of technology and know-how. With 2013. the recent progress of European Union (EU) candidate countries Montenegro and Serbia, Risks to the SEE6 near-term outlook are on and the agreement between Serbia and Kosovo the downside. Main external risks relate to presaging greater stability and security, the the pace of the increase in global interest rates perception of the regional investor risk may and sovereign borrowing costs arising from a decline gradually over time. Croatia’s accession possible tapering of quantitative easing in the to the EU, the opening of the accession U.S.; the Euro Area recovery; and deleveraging process of Serbia, and the progress made by and the potential exit of parent banks from the Montenegro, as well as recent political changes SEE6 countries. Internal risks relate to “reform in the region, may provide a renewed impetus fatigue” that may delay policy implementation, for reforms. The time to use that opportunity and daunting fiscal and debt challenges in is now. several countries. Also, slow resolution of NPLs, arrears accumulation in some countries, and depressed credit growth could further dampen prospects for growth. Beyond this difficult short-term horizon, how can SEE6 raise their longer-term growth prospects? While maintaining macroeconomic stability remains a top policy priority, structural reforms will have to be pursued with vigor. The nascent export-led growth of 2013 is a positive development, but sustaining it will be a challenge. In addition to the need to improve their fiscal positions, reduce public debts, and strengthen banking systems, SEE6 face significant structural challenges in improving productivity and competitiveness, including in the areas of the investment climate, the labor market, and the public sector. Overcoming these challenges is possible. A similar structural transformation challenge has been successfully met by the Baltics, Poland, the Czech Republic, and Slovakia, among other countries. They began their transition two decades ago under unfavorable conditions and Summary  |  3 SLOW ROAD TO RECOVERY Chapter 1: Recent Macroeconomic Developments Modest Growth after the Double-Dip Recession On the heels of a tepid recovery of the Euro Industry––especially manufacturing exports Area, the SEE6 region exited from recession and energy––drove the recovery in 2013. In in the first half of 2013. The combined real contrast to 2012, industrial output grew across GDP of the SEE6 countries rebounded from the region in the first half of 2013 (Figure 2). a 0.7 percent decline in 2012 to a 1.8 percent In Serbia, the start of production and exports growth (y-o-y) in the first half of 2013 (Figure by FIAT exceeded expectations, with over 1). Economic growth was backed by a slowly 100,000 cars exported so far this year. In the recovering external demand for SEE6 exports other SEE6 countries, industrial output growth (Box 1). While economic growth in Serbia and was weaker, but contributed positively to the Albania (at 1.4 percent) was led by industry, overall economic recovery. agriculture, and exports, the Macedonian growth (at 3.4 percent, the highest in the region) Good weather conditions supported a strong reflected a strong recovery in construction and contribution of agriculture to economic services in the first half of 2013. growth in SEE6. Because only a small share of Figure 1: Economic Growth Rates in SEE6 percent, annual growth percent, semi-annual y-o-y growth 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 ALB BIH KOS MKD MNE SRB SEE6 EU15 EU11 ALB BIH KOS MKD MNE SRB SEE6 EU15 EU11 JJ 2012 JJ H1 2012 JJ H1 2013 Source: National statistics offices, and World Bank staff estimates. Note: no quarterly data available for Kosovo and Bosnia and Herzegovina; figures are projection for the year. Chapter 1: Recent Macroeconomic Developments  |  5 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 2: Growth of Industrial Output in Table 1: Growth of Goods Exports 2013 in Euro Terms percent, q-o-q H1 H1 change 20 2012 2013 in % 18 Albania 720 840 16.7 16 Bosnia and Herzegovina 1,250 1,382 10.6 14 12 Kosovo 135 149 10.4 10 FYR Macedonia 1,507 1,523 1.1 8 Montenegro 194 209 7.7 6 Serbia 4,145 4,993 20.5 4 2 SEE6 7,951 9,096 12.6 Source: National statistics offices and World Bank staff estimates. 0 ALB BIH MKD MNE SRB JJ Q1 JJ Q2 Source: National statistical offices. arable land is irrigated and/or protected from with a 5.1 percentage point contribution to real floods, agricultural output critically depends on GDP growth. Preliminary data suggest that this weather conditions. In Serbia, after 20 percent export surge continued in the third quarter of drop in the previous year, agriculture grew 2013 with an estimated growth of 38.5 percent 21 percent in the first half of 2013 (y-o-y) with (y-o-y). better weather, contributing 1.6 percentage points to the overall GDP growth. Elsewhere, In addition to recovering external demand growth was less strong but positive. For from the EU, SEE6 countries’ export example, in FYR Macedonia, agriculture output growth was influenced by temporary grew 0.7 percent and anecdotal evidence from factors. For example, Montenegro and Bosnia Kosovo also suggests a good agricultural year and Herzegovina benefited from a surge in because of weather and donor-funded projects electricity exports from its hydropower plants in the sector. Greater supply helped reverse the using record water accumulations. Also, an food price inflation from a year ago. increase in food exports from Bosnia and Herzegovina to Croatia was related to that On the demand side, exports drove the country’s entrance to the EU. economic recovery in SEE6. The gradual recovery in the Euro Area helped the combined Domestic demand remained mostly goods exports of SEE6 to grow by close to depressed in SEE6 in 2013. Although statistics 13 percent (y-o-y), making a strong positive on the expenditure side of the SEE6’s GDP are contribution to overall economic growth only available for FYR Macedonia and Serbia, (Table 1). Serbia led this export surge with several indicators—credit, wages, inflation, investments by large foreign companies unemployment, imports, and household debt— (including FIAT, Michelin, and Stada): its all suggest depressed domestic demand. In exports grew by 20.5 percent in the first half Serbia, domestic consumption and investment of 2013 compared to the same period of 2012, had an especially negative contribution to GDP 6  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Box 1: External Developments in 2013 Following several years of weakness, growth in high-income countries is firming, including in the Euro Area  (Figure 3). High-income countries’ growth accelerated in Q2 2013, led by the United States; the Euro Area recovered after 6 quarters of contraction, and robust growth came to Japan. This acceleration softened in the Euro Area and Japan in the third quarter. In the US, growth led by the private sector increased to 2.8 percent from the previous quarter, despite rising interest rates and the effects of fiscal sequestration. The Euro Area recession has ended with annualized growth in Q2 at 1.2 percent across a range of economies and PMI surveys suggested stronger consumer and import demand. However, Germany and France lost the momentum in Q3, recording 1.2 percent and negative 0.5 percent growth rates, respectively. Economic activity has strengthened in China in recent months (Q3 up to 9.3% from 7.3% in Q2) and is recovering in other large middle-income economies including South Africa, Turkey and Brazil, although Q2 outturns disappointed in India and Mexico. Figure 3: Global Industrial Production and Figure 4: Borrowing Costs in Select Trade: Recovering European Countries: Moderating percent, 3m/3m saar credit default swap rates, basis points 30 1,800 25 1,600 20 1,400 15 1,200 10 1,000 5 800 0 600 -5 400 -10 200 -15 -20 0 1-Jan-10 1-Jun-10 1-Nov-10 1-Apr-11 1-Sep-11 1-Feb-12 1-Dec-12 1-Jul-12 1-May-13 1-Oct-13 Mar-11 Jun-11 Sep-11 Dec-11 Mar-13 Sep-13 Jun-13 Mar-12 Sep-12 Dec-12 Jun-12 ▬▬ Developing industrial production ▬▬ High income industrial production ▬▬ Spain ▬▬ Ireland ▬▬ Italy ▬▬ Portugal ▬▬ High income imports ▬▬ Developing country exports Source: World Bank and the Datastream. Source: World Bank and the Datastream. Capital flows to developing countries began to rebound and pressures on asset prices and currencies eased. However, there remain risks and uncertainty related to the eventual timing of tapering and its impacts on developing countries. Global capital flows remain volatile: gross capital flows to developing countries dropped in October, fully reversing the earlier rebound in September. Markets seem to be discriminating on the basis of domestic policy frameworks and risks. The transition to higher interest rates poses risks of a disorderly adjustment if rates rise too rapidly or a sudden stop in capital flows exposes country-level vulnerabilities. Although some adjustment has taken place (the average long- term cost of bond financing for developing countries tightened by 50 basis points since May), U.S. yields likely have a further 200–220 basis points to rise, with developing country yields likely to rise by an average 300–350 basis points in the medium-term. Economies with substantial vulnerabilities could see their cost of borrowing rise much more. The temporary decision by the Fed to maintain quantitative easing at current pace has delayed the impact on developing countries facing external financing vulnerabilities. Chapter 1: Recent Macroeconomic Developments  |  7 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 growth of about 2 percentage points each in productivity growth dipped to a level below the first half of 2013. Only in FYR Macedonia the one in 2008 in several countries, as sluggish and Kosovo did domestic demand strengthen, output growth failed to keep pace with the mainly because of increased investments. In upturn in employment (Figure 6). FYR Macedonia, for example, investment increased by 8.2 percent in the first half of 2013 Sluggish productivity growth and rising (y-o-y), driven by investment in large public unit labor costs in several countries affected sector projects. negatively economic growth. Only in Albania Figure 5: SEE Labor Productivity in SEE vs. Figure 6: Labor Productivity in the SEE EU11 and EU15 index (2008=100) index (2008=100) 110 120 105 110 100 95 100 90 90 85 80 80 75 70 70 60 65 60 50 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 2012 ▬▬ SEE5 (ex Kosovo) ▬▬ EU-11 ▬▬ EU-15 ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia Source: National statistics offices, World Bank staff estimates. Source: National statistics offices, World Bank staff estimates. Against these short-term developments, and Serbia did real unit labor costs decline productivity growth—a key driver of long- after 2008 (Figure 7), aided in part by the run growth—slowed substantially in the stronger productivity growth in these two past two years. In the years prior to the global economies compared to the rest of the SEE. financial crisis, labor productivity grew faster But real wages in Bosnia and Herzegovina and in the SEE6 countries than EU11 and EU15, FYR Macedonia, for example, continued to a pattern that was sustained in the immediate grow, while productivity growth fell (Figure aftermath of the crisis (Figure 5).2 Since 8). This led to further increases in unit labor the beginning of 2012, however, SEE labor costs in these countries despite the persistent slack in their labor markets. The labor demand and trade competitiveness channels adversely 2 EU11 comprises Bulgaria, Croatia, the Czech Republic, Estonia, affected economic growth. Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, and Slovenia. The group of EU15 countries comprises: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. 8  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Figure 7: Real Unit Labor Costs Figure 8: Contributions to Change in Unit Labor Costs Since 2008 index (2008=100) percentage points 120 15 110 10 100 5 90 0 80 -5 70 -10 60 -15 50 -20 2004 2005 2006 2007 2008 2009 2010 2011 2012 ALB BIH MKD MNE SRB ▬▬ Albania ▬▬ Bosnia & Herzegovina ▬▬ FYR Macedonia JJ Real wage growth JJ Productivity growth QQ Total change in unit labor costs ▬▬ Montenegro ▬▬ Serbia Source: National statistics offices, World Bank staff estimates. Source: National statistics offices, World Bank staff estimates. Note: 2009 reflects a structural break in the data for FYR Macedonia due Note: 2009 reflects a structural break in the data for FYR Macedonia due to methodological revisions in the definition of gross wages, which excluded to methodological revisions in the definition of gross wages, which excluded food and transport allowances in the period 2004–2009. food and transport allowances in the period 2004-2009 Continued Improvements in Trade and External Debt Current account balances narrowed in all financing. The FDI share of CAD financing SEE6 countries on the back of recovering grew strongly from 18.4 percent in 2012 to European Union (EU) demand for exports. about 45.3 percent in the first half 2013. FDI Both increases in exports and declines in financed one third of the CAD in Serbia and imports contributed to a major rebalancing Montenegro, about a half of FYR Macedonia’s, in trade and improvements in current account two-thirds of Bosnia and Herzegovina’s, and balances (Figure 9, Figure 10 and Figure 11). over 90 percent of Kosovo’s and Albania’s. While intraregional SEE6 trade grew in 2012, exports began to shift towards the EU in Average FDI flows to the SEE6 countries 2013. That was true especially for Bosnia and increased in 2013, albeit from low levels. Herzegovina, FYR Macedonia, and Serbia; FDI in Serbia and FYR Macedonia—mostly while Montenegro’s and Kosovo’s share of in manufacturing—doubled, although from a exports to the SEE region increased. very low base. In Kosovo and Albania, the FDI were directed mostly towards infrastructure— Current account deficits (CAD) were the Prishtina Airport and hydro-power plants, primarily financed by portfolio investments respectively. and FDI. Portfolio investments were the largest source of financing in the first half of While remittances to SEE6 decreased in 2013, accounting for almost half of CAD’s 2013, they remained broadly resilient to the Chapter 1: Recent Macroeconomic Developments  |  9 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 9: SEE6 Combined Current Account Figure 10: SEE6 Countries’ Half Year Current and Trade Balances Account Balance percent of GDP percent of GDP 0 0 -5 -5 -7.0 -10 -9.9 -15 -10 -11.9 -20 -14.9 -15 -25 -30 -20 -22.0 -22.8 -35 -25 -40 2011 2012 H1 2013 MNE KOS SEE6 ALB SRB MKD BIH JJ CAD JJ Trade balance JJ H1 2011 JJ H1 2012 JJ H1 2013 Source: Central banks, IMF WEO, and World Bank staff calculations. Source: SEE6 Central Banks. Note: Montenegro’s current account deficit narrows usually in Q3 due to the main tourist season, producing a lower annual external deficit. Figure 11: SEE6 Export Growth Figure 12: Worker Remittances 2010–H1 2013 percent percent of GDP 30 16 25 14 20 12 15 10 10 8 5 6 0 4 -5 2 -10 0 ALB BIH KOS MKD MNE SRB SEE6 KOS BIH SEE6 ALB MNE SRB MKD JJ 2011 JJ 2012 JJ H1 2013 JJ 2011 JJ 2012 JJ H1 2013 Source: Central banks, IMF WEO, and World Bank staff calculations. Source: SEE6 central banks. Note: Albania, Kosovo, and Bosnia and Herzegovina define remittances as including compensation of employees; Serbia and Montenegro use narrower definitions. Data for FYR Macedonia include only workers remittances coming through official bank channels and reported as such, but not all private transfers. Eurozone crisis. Remittances to the region was more than 2 percentage points of GDP, as a declined by 0.5 percentage point as a share of result of many migrants returning from Greece. GDP in the first half 2013 (Figure 12) mainly because of the economic conditions migrants External debt remained high, albeit receding, faced in Italy and Greece. The largest drop was mainly due to private sector deleveraging in Albania, where the size of the contraction (see fiscal section). Total external debt in 10  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Figure 13: Average SEE6 External Debt Figure 14: Total Public and Private External Debt 2010–H1 2013 percent of GDP percent of GDP 80 120 70 69.5 100 65.8 67.1 60 63.3 80 50 40 60 30 30.5 30.6 40 26.4 20 24.4 20 10 0 0 2010 2011 2012 H1 2013 MNE SRB SEE6 MKD BIH ALB KOS JJ External debt JJ o/w Gov. debt JJ 2010 JJ 2011 JJ 2012 JJ H1 2013 Source: SEE6 central banks and ministries of finance (MoF). Source: SEE6 central banks and ministries of finance; IMF; World Bank. Note: Montenegro’s and Kosovo’s external debt are estimates. Kosovo external debt also excludes potential debt to the London Club and the Paris Club. SEE6 declined by 2.4 percentage points to Nascent Employment Gains 67.1 percent of GDP in the first half 2013, mainly because of the large 5.2 percentage point decline of Serbia’s external debt (Figure 13, Figure 14). In addition to Serbia, external While employment rates in SEE6 improved debt declined in FYR Macedonia by 0.9 percent in 2013, their increase made only a small of GDP, and in Kosovo3 and Albania by about dent in the high unemployment rates. 0.3 percent of GDP, respectively (Figure 14). Compared to the EU11 and EU15, where employment levels remained noticeably below their pre-crisis peaks, the SEE6 employment was nearly back to its 2008 pre-crisis peak level in the first half of 2013 (Figure 19). However, gains in employment are slow to translate into substantial decline in unemployment rates. Albania, FYR Macedonia and Montenegro experienced the strongest job growth since 2010, while employment in Serbia and Bosnia and Herzegovina remains depressed (Figure 16). Even where employment has recovered meaningfully since 2010, the gains have not been broad-based, but concentrated mostly on service sectors. In contrast, industry continued 3 External private debt for Kosovo is an estimate and might be slightly underestimated. to lose jobs (Figure 17). Chapter 1: Recent Macroeconomic Developments  |  11 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 15: Employment in Regional Context Figure 16: SEE: Paths of Employment Recovery index (2008=100) index (2008=100) 105 110 105 100 100 95 95 90 90 85 85 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 ▬▬ SEE5 (ex Kosovo) ▬▬ EU-11 ▬▬ EU-15 ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia Source: Eurostat, National statistics offices. Source: National statistics offices. Unemployment in the SEE6 has remained Figure 17: Sectoral Drivers of Employment stubbornly high, despite slight recent declines Recoveries in some countries. The average unemployment percentage points rate for the SEE6 was 23.6 percent as of mid- 10 2013, well above the EU-11 average, and 8 showing little improvement from peak crisis 6 levels (Figure 18). Only in FYR Macedonia 4 did unemployment decline substantially, albeit from very high levels. Albania’s unemployment 2 rate (12.8 percent) remained the lowest among 0 the SEE6, while Kosovo’s, at 30.9 percent, -2 remained the highest.4 By contrast, in EU11 and -4 EU15, unemployment rates have continued to Albania FYR Macedonia Montenegro rise (Figure 19). JJ Agriculture JJ Industry JJ Services QQ Total Source: Eurostat, National statistics offices. 4 Kosovo recently released the 2012 unemployment figure from its Labor Force Survey after a 3-year gap in the data. 12  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Figure 18: Unemployment Rates 2013 Figure 19: Unemployment Rates in Regional Context percent of labor force percent of labor force 40 30 35 33.5 25 30 27.6 30.9 25.5 28.8 27.5 20 25 20.5 23.5 20 15 19.2 13.8 15 10 12.8 10 5 5 0 0 ALB MNE SRB BIH MKD KOS 2007 2008 2009 2010 2011 2012 H1 2013 QQ Crisis time ▬▬ SEE6 average ▬▬ EU11 average ▬▬ SEE5 ▬▬ EU-11 ▬▬ EU-15 Source: National Labor Force Surveys. Source: Eurostat, National LFS data, World Bank staff estimates. Note: Q2 2013 data for all except Kosovo (2012). Kosovo changed its LFS methodology in 2012, making previous year’s figures incomparable. Disinflation Inflation in SEE6 decelerated in the first as of September, CPI inflation in SEE6 three quarters of 2013 on the back of (2.5 percent) converged substantially, only one stabilizing energy and food prices. The percentage higher than that of its regional peers drop in CPI inflation—relative to peak rates (Figure 23). in December 2012/January 2013—was substantial: it ranged from 7.9 percentage With subsiding inflation and still-high points in Serbia to 3.5 percentage points spare capacity, some SEE6 central banks in Kosovo, and 3 percentage points in FYR eased monetary policy. Specifically, still-large Macedonia (Figure 20). Most of the slowdown output gaps in SEE6 (Figure 24) supported reflects the dissipation of one-off factors that some loosening in the countries with flexible pushed up inflation in 2012––administered exchange rates (Albania and Serbia) and prices, some tax hikes, and the impact of bad managed pegs (FYR Macedonia). Policy rates weather on agricultural output and the food were cut by an average of 50 basis points in supply. Food inflation dropped by 9 percentage the first half of 2013 (Figure 25). To support points (Figure 21), while energy inflation fell liquidity, “euroized” countries (Bosnia and 5 percentage points. Serbia was an exception where inflation temporarily spiked in August owing to a one-time increase in retail electricity prices (Figure 22). With these developments, Chapter 1: Recent Macroeconomic Developments  |  13 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 20: CPI inflation Figure 21: Food Price Inflation percent (y-o-y) percent (y-o-y) 14 20 18 12 16 10 14 12 8 10 6 8 6 4 4 2 2 0 0 -2 -2 -4 Dec-11 Mar-12 Jun-12 Sep-12 Dec-11 Mar-12 Jun-12 Sep-12 Sep-13 Sep-13 Dec-12 Mar-13 Jun-13 Dec-12 Mar-13 Jun-13 ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ Kosovo ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ Kosovo ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia ▬▬ SEE6 ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia ▬▬ SEE6 Source: National statistical offices and World Bank staff calculations. Source: National statistical offices and World Bank staff calculations. Figure 22: Energy Price Inflation in SEE6 Figure 23: Regional CPI Inflation Comparison percent (y-o-y) percent (y-o-y) 18 8 16 7 14 12 6 10 5 8 6 4 4 3 2 0 2 -2 1 -4 -6 0 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Jan-13 Feb-13 Sep-13 Aug-13 Sep-13 Dec-12 Mar-13 Jun-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ Kosovo JJ SEE6 JJ EU15 JJ EU11 ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia ▬▬ SEE6 Source: National statistical offices and World Bank staff calculations. Source: National statistical offices and World Bank staff calculations. Herzegovina, Kosovo, and Montenegro)5 Despite these efforts, SEE6 experienced maintained relatively low rates of required limited recovery of monetary aggregates, reserves: 9.5 percent in Montenegro, 10 percent mirroring sluggish real activity. The real in Bosnia, and 10 percent in Kosovo. broad money supply (M2) in Albania, FYR Macedonia, Montenegro, and Serbia has not increased appreciably since mid-2010. Only in Bosnia and Herzegovina and Kosovo has 5 Kosovo and Montenegro have unilaterally adopted the euro as there been a measurable rise in real M2 since their sole legal tender, while Bosnia and Herzegovina runs a euro- based currency board. the crisis, but the scope for further expansion 14  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Figure 24: Output Gaps in SEE6* Figure 25: Official Policy Rates percent of potential GDP percent 10 20 8 18 16 6 14 4 12 2 10 0 8 6 -2 4 -4 2 -6 0 2007 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 ▬▬ Montenegro ▬▬ Serbia ▬▬ FYR Macedonia ▬▬ Albania ▬▬ Albania ▬▬ FYR Macedonia ▬▬ Serbia ▬▬ Bosnia and Herzegovina ▬▬ Euro area (ECB refi rate) Source: IMF WEO and Staff country reports. Source: ECB, National statistical offices. Note: *Estimates for Kosovo are not available. Figure 26: Real Broad Money Supply index (2009:Q1=100) 125 Depressed Credit Growth 120 115 110 Funding conditions for SEE6 countries 105 improved somewhat in 2013. After supportive 100 measures taken by major world central banks, 95 market sentiment improved and risk aversion 90 declined.6 Credit Default Swaps (CDS) Sep-12 Sep-13 Mar-09 Sep-09 Mar-10 Sep-10 Sep-11 Mar-11 Mar-12 Mar-13 spreads reached their lowest levels in most ▬▬ SEE6 ▬▬ EU15 ▬▬ EU11 SEE6 countries since early 2011 and equity Source: IMF IFS, National central banks. markets rose (Figure 27, Figure 28). Gross Note: 2013:H1 data is expressed as an annualized rate. capital inflows to SEE6 region rose in 2013, amounting to 0.5 percent of GDP. FDI saw a is constrained by the limited external inflows boost of 0.7 percent of GDP in the first half within these countries’ exchange arrangements. of 2013 and portfolio investments remained On balance, however, the post-crisis monetary robust as capital markets remained supportive recovery in SEE6 has been broadly on par with of SEE6 sovereign bond issuances. regional peers, albeit considerably more volatile (Figure 26). 6 A Bank for International Settlements (BIS) study “The euro area crisis and cross-border bank lending to emerging market” (http:// www.bis.org/publ/qtrpdf/r_qt1212f.htm) confirms that between mid-2011 and mid-2012 it was primarily parent bank stress that drove deleveraging. Chapter 1: Recent Macroeconomic Developments  |  15 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 27: Funding and Funding Costs for Figure 28: CDS Spreads of SEE countries SEE6 Countries in million of US$ basis points basis points 3,000 1,000 1,400 2,000 1,200 800 1,000 1,000 600 800 0 400 600 -1,000 400 200 -2,000 200 -3,000 0 0 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q1-13 Q1-11 Q4-12 Q2-11 Q3-11 Q2-13 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Oct-13 JJ Change in BIS reporting banks external position vis-à-vis SEE6, lhs* ▬▬ Albania ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia ▬▬ Parent banks CDS spread average, rhs** ▬▬ SEE6 sovereign CDS spread, bps, rhs*** Source: Bloomberg, Bank for International Settlements (BIS) and World Source: Bloomberg. Bank staff calculations. Note: *Countries included: Albania, Bosnia and Herzegovina, FYR Macedonia, Montenegro and Serbia. Table 2: Asset Shares of Foreign Banks in ** Banks included: Raiffeisen Bank, Erste Bank, Banca Intesa, UniCredit Bank, Societe Generale, National Bank of Greece (NBG) and Alpha Bank. SEE6, 2012 *** Countries included: Albania, FYR Macedonia, Montenegro and Serbia. percent of country’s total assets Austria Greece Slovenia However, European foreign banks continued Albania 28.8 18.8 to deleverage from the SEE6 region. Bosnia and Herzegovina 37.2 8.5 European foreign banks, which dominate the Kosovo 24.1 16.1 SEE6 financial landscape (Table 2) remained Macedonia 4.7 23.0 16.9 under market and regulatory pressures that Montenegro 21.2 17.0 prevented them from expanding their balance Serbia 16.4 14.0 3.5 sheets and encouraged their subsidiaries to Source: Bankscope, Central Banks. keep diversifying their sources of funding. In fact, compared to the end of the third quarter the European Commission’s Directorate of 2012, the international exposure by foreign General for Competition and the National banks dropped in SEE6 financial sector as Bank of Greece (NBG) for restructuring of the parent banks continued to reduce their presence bank are not yet concluded, one of the reported in the region. Austria’s Hypo Alpe Adria Bank, options would be for the NBG to withdraw for example, put its subsidiaries in the region from Southeastern. (Bosnia and Herzegovina, Montenegro and Serbia) for sale. Slovenia’s Nova Ljubljanska Against this backdrop, SEE6 countries made Banka (NLB) recently reached a restructuring some progress in implementing banking plan with the European Commission to reforms over the past year with the aim to downsize portfolio, raising the risk of divestment improve their resilience and supervisory from the region. While negotiations between capacity, but challenges remained. Macro- 16  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Figure 29: Non-performing Loans Figure 30: Asset Quality of Loan Portfolio, December 2012 percent of total loans percent of total loans 30 60 25 50 20 40 15 30 10 20 5 10 0 0 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ Dec-12 JJ Jun-13 QQ Peak since 2008 JJ Impaired (Category 2) JJ Substandard JJ Doubtful SS Pre crisis level (end 2007) JJ Loss Source: National authorities and World Bank staff calculations. Source: Central Banks of the SEE6 countries. Note: Data for pre-crisis NPL level (2006–2008) for Serbia refers to end of 2008 level only. prudential frameworks were strengthened companies to service their loans. NPLs reached to varying degrees, home-host relations worryingly high levels of above 20 percent of improved, and several countries made efforts total loans in Albania and Serbia, and about to reduce their elevated NPLs levels (including 18 percent in Montenegro. In addition, with foreign technical assistance (see Box 2). impaired loans (Category 2 loans), which However, there remain four challenges: accounted for the bulk of the newly-created NPLs, remained still high in some countries (i) taming the still rising NPLs problem, and need close monitoring (Box 2). (ii) bringing the high loan-to-deposit ratios down, in some countries Loan-to-deposit ratios continued to be (iii) increasing bank profitability, and high in three of the six countries in the (iv) resuming credit growth. region ( Figure 31). Serbia has reduced its loan-to-deposit ratio and its banks increased NPLs continued to rise in the first half of their liquidity considerably, but it still has the 2013, reaching peak levels in most of the highest ratio in the region, at 140 percent in region. NPLs started rising in mid-2012 and mid-2013. Montenegro has the second highest continued to increase in each of the SEE6 level at 122 percent in mid-2013 (down from countries in the first half of 2013 (Figure 29). 167 percent in mid-2009), similar to Bosnia Their rise in SEE6 reflected a mix of weak and Herzegovina. economic fundamentals, worsening loan quality (Figure 30) and weak insolvency regimes. In Bank profitability remained under pressure. addition, weak fiscal discipline resulted in Banks’ profitability, measured through the public sector arrears, which constrained private average return on assets (ROA) fell in the sector liquidity and decreased the ability of first half of 2013 in Albania, Bosnia and Chapter 1: Recent Macroeconomic Developments  |  17 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Box 2: NPL Resolution Efforts in SEE6: The Experience to Date  ll six South East Europe countries have now received or begun discussions on external assistance to A support the resolution of NPLs. Carrying out NPL resolution processes requires significant efforts in a number of key dimensions, inter alia, including: (i) developing a clear, objective grasp of financial and regulatory incentives at play, both locally and internationally, legal and regulatory impediments, and shortfalls in organizational and technical abilities in the banks; (ii) introduction of voluntary debt restructuring frameworks, and a judiciary prepared to execute resolution of those uncooperative borrowers; (iii) a willingness to set achievable interim and longer-term NPL reduction goals and supervisory resolve to have them enforced; and (iv) introduction of voluntary debt restructuring frameworks, and a judiciary prepared to execute resolution of those uncooperative borrowers; and (v) engagement of a number of key local stakeholders to adopt the needed measures. All these dimensions have to be carefully sequenced in accord with an agreed, time-bound strategy. With the above set pre- conditions in place, the NPL reduction process is likely to require at least 18 months to demonstrate durable results. Albania: The Bank of Albania (BoA) with the Government has initiated a wide range of reforms in recent  years to support the resolution of NPLs, covering legislative, procedural and taxation issues. In a bid to draw from international best practice to support the mitigation of NPLs, the BoA entered into an MOU with the World Bank Vienna Financial Sector Advisory Center (FinSAC) in October 2012. Recent 2013 amendments to the Civil Procedure Code adopted with FinSAC support aim to shorten and simplify collateral enforcement procedures and significantly reduce the court’s right to intervene in enforcement or foreclosure on real property. However, banks continue to face important tax ambiguities in their efforts to write off unrecoverable NPLs. To bring clarity to these matters, the Ministry of Finance on behalf of the Tax Authority launched in November 2013 a Working Group with the BoA, supported by legal and accounting experts from the respective institutions. As banks are continuing to keep a significant portion of unrecoverable problem loans in their balance sheets, if these tax ambiguities were resolved, banks’ could lower NPL levels by 5–6 percentage points. In October 2013, Bank of Albania has launched an NPL Resolution Platform involving enhanced supervisory intrusiveness with regard to NPL recovery and resolution strategies by banks, supported by FinSAC. The outcome of this initiative will be to strengthen the ability of the Central Bank to direct banks to step up their efforts to reduce the NPL stock in a compressed time-frame. Bosnia and Herzegovina: In response to the authorities request for technical assistance for an NPL resolution framework, in  April 2013 the IMF conducted a diagnostic study to define various short- and long-term measures to help clean up the NPLs. The report is slated to identify steps to strengthen the framework for NPL resolution by removing tax and institutional obstacles. The IMF is considering providing follow-up technical assistance in two key areas: i) launching an “Istanbul Approach” to bad debt resolution, whereby debt of distressed companies with multiple creditors would be restructured collectively by a committee of creditors, and ii) developing a law on factoring and/or proposing new legislation on asset management companies to facilitate banks’ sale of problem assets. Additionally, the IMF diagnostic team findings point to a critical need to improve tax laws related to loan restructuring and loan sales, out–of- court corporate debt restructuring, the corporate insolvency law, and to the introduction of a comprehensive consumer bankruptcy regime. Taking advantage of the forthcoming asset quality review of selected banks requested by the IMF, FinSAC has proposed to add an NPL recovery mapping module that would create more transparency and stronger accountability for the banks’ efforts to de-risk their balance sheet. 18  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Kosovo: Institutionally, there is no functional system for the collective resolution of NPLs and enterprise  distress. The modern liquidation and re-organization statute, while broadly consistent with good practice, lies entirely dormant due to the lack of a framework for the training, licensing, supervision, or accountability of insolvency professionals. There is only one specialized commercial court, which is understaffed and under-resourced. Only recently did Kosovo introduce notary services and mediation services as alternative dispute resolution mechanisms, working under the Kosovo Chamber of Commerce and American Chamber of Commerce. Montenegro: The Central Bank of Montenegro (CBCG) has taken the lead in introducing the “Podgorica  Approach,” a new integrated program to enhance NPL reduction. With technical assistance provided by the World Bank’s Vienna-based Financial Sector Advisory Center (FinSAC), the CBCG is in the process of implementing a more formal framework to enhance NPL reduction activities. Based loosely on the London Rules, the approach is designed to create an incentive-based, voluntary framework to support real restructuring (operational as well as financial) and to provide solutions for debt restructuring on a systematic scale. The approach is grounded in the proposed Lex specialis Law on Voluntary Financial Restructuring of Debts, which is expected to be enacted in late 2013. As part of the analytical underpinnings to establish the costs and benefits of financial restructuring, FinSAC has recently completed an extensive assessment of the recoverability of the four largest NPL bank portfolios, involving bottom-up analysis of 120 large non performing borrowers. The outcome was a demonstration of the critical importance of a successful financial restructuring initiative, as only a small portion of the NPL portfolio is expected to cure without strong remedial action. FYR Macedonia: Following a World Bank Technical Assistance project on contingency planning in mid-2012, the  National Bank of Republic of Macedonia has developed an action plan aimed at enhancing crisis preparedness. The project focused on the tools, resources, powers and interagency coordination mechanisms available to the authorities in the event of a systemic crisis. The main goal of the proposed crisis contingency plan is to prevent and reduce the impact of a crisis by taking actions to: (i) better understand the risks (including NPL-related risks) and inter-connections in the financial system, (ii) use supervision to strengthen resilience of banks, (iii) establish relevant legislation and policies (including for NPLs), and (iv) have a strategy to manage a crisis using carefully selected scenarios.. FinSAC is contributing to building capacity at the NBRM, focusing on system-wide NPL reduction. Serbia: Although fully provisioned (based on local prudential and accounting standards), the high level  of NPLs is a source of serious concern in Serbia. Through amendments to the decision on the Classification of Bank Balance Sheet Assets and Off-balance Sheet Items that were passed in December 2012, a more lenient regulatory treatment of overdue loans fully guaranteed with mortgages was introduced. Regulatory impediments have been eased for the sale of distressed assets to their corporate clients. Out-of-court restructuring of NPLs has been introduced, but banks’ response has been quite tepid, with only few recorded voluntary restructurings to date. There are issues with capacity of the designated mediator (Chamber of Commerce) and lack of awareness about the system by companies. The National Bank of Serbia drafted a set of amendments on the Decision on the Classification of Bank Balance Sheet Assets and Off-balance Sheet Items in order to remove some of the obstacles for dealing with NPLs. The amendments were put for public debate on November 27, 2013. Chapter 1: Recent Macroeconomic Developments  |  19 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 31: Loan-to-Deposit Ratios Despite ample liquidity and notable cuts 180 in policy rates throughout 2013, real credit 160 growth remained elusive in the SEE6 region, 140 failing to support economic recovery. Banks 120 in SEE6 countries were well-capitalized (Figure 100 32). Liquidity in the banking system was also 80 high at 25–35 percent of total assets (Figure 60 33). High liquidity and capital adequacy served 40 as buffers against volatile financial flows and 20 uncertainty about the funding and potential 0 exit of parent banks. However, rapidly ALB BIH KOS MKD MNE SRB JJ Dec-12 JJ Jun-13 QQ Peak level since 2006 increasing NPLs, the introduction of tighter Source: National authorities and World Bank staff calculations. credit underwriting standards, and banks’ Note: Due to the accounting harmonization with the IFRS, data for Montenegro is not comparable to the last Report. efforts to clean their balance sheets and contain costs added pressure on lending in 2013. This Herzegovina and FYR Macedonia, and only discouraged banks from resuming credit, increased slightly in Serbia and Kosovo. In especially to SMEs. As a result, overall credit Montenegro, as positive credit growth resumed, growth in 2013 further weakened in the SEE6 bank profitability, too, turned positive for the region, except in Montenegro (Figure 34). first time since mid-2008. However, increased provisioning for the rising NPLs, additional Against this backdrop, what is the remaining regulatory compliance, and lower revenues priority reform agenda in the financial continued to put pressure on profitability and sector? First, the successful and sustainable the banks’ willingness to lend. reduction of NPLs is the most important task ahead. As noted above, since the last edition Figure 32: Capital Adequacy Ratio Figure 33: Liquidity Ratio 25 45 40 20 35 30 15 25 20 10 15 10 5 5 0 Q1-09 Q3-09 Q1-10 Q3-10 Q1-11 Q3-11 Q1-12 Q3-12 Q1-13 0 ALB BIH KOS MKD MNE SRB JJ Dec-12 JJ Jun-13 QQ Average (2006–08), quarterly ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia Source: National authorities and World Bank staff calculations. Source: National authorities and World Bank staff calculations. Note: Data for Serbia for -Average 2006-2008 quarterly, refers to 2008 Note: Data for Serbia for -Average 2006-2008 quarterly, refers to 2008 only. only. 20  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Figure 34: Credit Growth Rates evolution of foreign currency exposure to percent change unhedged borrowers and take measures to 60 limit or reduce lending in foreign currency or 50 lending indexed to foreign currencies. 40 30 20 Persistent Fiscal Pressures 10 0 -10 ALB BIH KOS MKD MNE SRB JJ 2009 JJ 2010 JJ 2011 JJ 2012 JJ Q2 2013 QQ Average growth 2003–05 SEE6 fiscal deficits remained high, in part Source: National authorities and World Bank staff calculations. Note: Average growth rate for the period 2003-2005 for Albania because of structural rigidities in public and Serbia, and for the period 2004–2005 for FYR Macedonia and Montenegro. expenditures, weak tax bases, and depressed fiscal revenues. Fiscal balances were not of the Report (June 2013), NPL levels had restored in 2013, and deficits remained close to risen considerably and credit growth remained their peak levels in 2009. Despite some efforts subdued. This highlights the need for decisive to control expenditure in 2013, governments and comprehensive measures to bring down did not address the key structural rigidities NPL levels. Second, further strengthening of underlying high public expenditures, namely, the macro-prudential framework is needed. the high spending on wages and on poorly- Even though considerable work has been targeted social transfers (Figure 35, Figure 36). done, additional effort is needed in reinforcing In addition, the large informal economy and the capacities of the regulatory authorities the weak regional economic recovery resulted (both human and financial) to implement in revenue losses in some of the countries recommendations of assessments already made. (Albania, Montenegro, Serbia,) where Third, foreign currency lending poses risks expenditure cuts were insufficient to contain not fully recognized in the affected countries. deficits. In others (Serbia), expenditures too Weak economic fundamentals and high level of continued to increase, postponing the needed foreign currency and foreign currency-indexed fiscal adjustment. As a result, the SEE6 average lending (ranging from 79 percent in Serbia to fiscal deficit remained on a rising trajectory 49 percent in FYR Macedonia7) pose a potential and is projected to reach 4.2 percent of GDP risk in countries with domestic currencies. in 2013 (Figure 37). In this regard, SEE6 fiscal These countries should monitor closely the performance remained worse compared to EU11 countries, whose average un-weighted deficit stood at 3.6 percent of GDP 2013. 7 FYR Macedonia managed to decrease foreign currency lending from 56 percent of all loans at end 2009 to the current level of 49 percent, while at the same time increased the amount of SEE6 countries with narrowing fiscal deposits in local currency from 41 percent of all deposits at end 2009 to 56 at end September 2013. deficits in 2013 were those that were able Chapter 1: Recent Macroeconomic Developments  |  21 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 35: Average Structural Fiscal Balance Figure 36: Structural Fiscal Balances and Economic Growth percent percent of GDP 8 8 6 6 4 4 2 2 0 0 -2 -4 -2 -6 -4 -8 -6 -10 2000 2002 2004 2006 2008 2010 2012 2005 2006 2007 2008 2009 2010 2011 2012 ▬▬ Structural balance ▬▬ Average growth ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ Kosovo ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Serbia Source: National governments and World Bank staff calculations. Note: The structural balance refers to the general government cyclically adjusted balance. The cyclically adjusted balance is the fiscal balance adjusted for the effects of the economic cycle using the Hodrick-Prescott (HP) filter. Figure 37: Fiscal Deficits Figure 38: Contribution Toward Change in Deficits, 2012–13 percent of GDP 8 3 7 2 6 1 5 4 0 3 -1 2 -2 1 0 -3 ALB BIH KOS MKD MNE SRB EU11 SEE6 ALB BIH KOS MKD MNE SRB SEE6 JJ 2011 JJ 2012 JJ 2013 JJ Expenditure contribution JJ Revenue contribution QQ Change in deficit Source: World Bank staff calculations. Source: World Bank staff calculations. to cut expenditures  (Figure 38). In Bosnia Kosovo’s fiscal deficit is projected to decline to and Herzegovina and Serbia, assuming 2.4 percent of GDP, down from 2.7 percent. implementation of the budget plans, spending In Kosovo, the introduction of a fiscal rule cuts are projected to more than offset revenue sets a statutory maximum deficit at 2 percent shortfalls and contribute to reducing fiscal of GDP from 2014 onwards. In contrast, in deficits by between 0.5 and 3 percent of Albania, the deficit is expected to increase by GDP. In Serbia, the fiscal deficit is projected 2.5 percentage points of GDP in 2013 (relative to narrow from 7 to 6.5 percent of GDP. to the original target) reaching 5.9 percent, on 22  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY account of slippages in revenue collection as fiscal balances. Despite the recent increases well as increased election-related spending. in VAT rates and excises in some countries, which yielded additional revenues (notably A weak tax base and an inefficient tax Montenegro and Serbia), revenues in SEE6 administration further burdened the fiscal decreased by an average of around 0.6 percent adjustment by dampening revenues in of GDP in 2013. The main factors behind SEE6. The average revenue-to-GDP ratio the weak SEE6 revenues seemed to be partly fell from 37 percent in 2008 to 35.1 percent structural (weak tax administration and in 2012, despite the resumption of growth. custom revenues) and partly cyclical, reflecting Weak tax collections affected negatively SEE6’s depressed demand and lower VAT revenues. Figure 39: Public Expenditure The large fiscal imbalances in SEE6 were percent of GDP fueled by a rigid structure of public 60 expenditures, concentrated on public wages and social transfers (Figure 39). On average, 50 the SEE6 countries’ wage bill is very high at 40 over 9 percent of GDP in 2012, and was still rising from pre-crisis levels (Figure 40 and 30 Figure 41). Social transfers, comprising last- 20 resort social assistance, pensions and war- 10 related benefits, among others, at 12.5 percent of GDP, remained large and poorly targeted, 0 ALB BIH KOS MKD MNE SRB EU11 SEE6 failing to protect the poor (Figure 42 and JJ 2011 JJ 2012 JJ 2013 Figure 43). In Bosnia and Herzegovina, over Source: National authorities, Eurostat and staff calculations. 12 percent of social benefits were estimated Figure 40: Contribution Toward Change in Figure 41: Wage Bill and Social Benefit Spending, 2009–12 Spending, 2012 percent of GDP 8 35 6 30 4 2 25 0 20 -2 -4 15 -6 10 -8 5 -10 -12 0 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ CoE JJ G&S JJ Interest JJ Subsidies JJ Grants JJ Compensation of employees JJ Social benefits JJ Social benefits JJ Other JJ Capital QQ Total Source: World Bank staff estimates. Source: World Bank staff estimates. Chapter 1: Recent Macroeconomic Developments  |  23 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure 42: Benefits Coverage of Households Figure 43: Benefits to Top and Bottom Quintiles Households percent percent 35 9 90 14 8 80 30 12 7 70 25 10 6 60 20 5 50 8 15 4 40 6 3 30 10 4 2 20 5 2 1 10 0 0 0 0 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ Bottom quintile, lhs QQ Top quintile, rhs JJ Bottom quintile, lhs QQ Top quintile, rhs Source: National authorities and Europe and Central Asia Social Protection expenditures and evaluation Database, World Bank. Note: Data are from the following years ALB: 2008; Bosnia and Herzegovina: 2007; KOS: 2009; MKD: 2010; MNE: 2011; SRB: 2010. to go to the wealthiest quintile and in FYR social protection to the poor and prospects for Macedonia, over 11 percent. By contrast, less shared prosperity of the bottom quintiles of the than 40 percent of benefits reached the bottom population. quintile in Bosnia and Herzegovina. There and in Kosovo, war veterans’ benefits took up Public debt levels continued to rise in 2013 a large share of social protection budgets but in most SEE6 countries. Average public failed to reach the poor and most vulnerable. debt (excluding guarantees) increased from There is, therefore, ample scope to rationalize 36.2 percent of GDP in 2011 to 42 percent social expenditures in this area while increasing in 2012 and 44.8 percent of GDP in 2013. Figure 44: General Government Debt without Figure 45: State Guarantees Guarantees percent of GDP percent of GDP 70 14 60 12 50 10 40 8 30 6 20 4 10 2 0 0 ALB BIH KOS MKD MNE SRB EU11 SEE6 ALB BIH KOS MKD MNE SRB JJ 2011 JJ 2012 JJ 2013 (proj.) JJ 2012 JJ 2013 (proj.) Source: World Economic Outlook, April 2013 and Kosovo Ministry of Source: National authorities and World Bank staff estimates. Finance. 24  |  Chapter 1: Recent Macroeconomic Developments SLOW ROAD TO RECOVERY Levels of public debt remained particularly worrisome in Albania, Montenegro, and Serbia in 2013. Notably, the Albanian public debt is projected to exceed 66 percent of GDP without including the announced payment of arrears, which amount to another 4.1 percent of GDP. State guarantees are non-marginal and can add to public debt pressures (Figure 44 and Figure 45). These reached around 7.5 percent of GDP in 2012, but are projected to fall in 2013, because of a call on a large guarantee in Montenegro. Standard and Poor’s sovereign credit ratings have remained unchanged since June 2013 (Table AI.1). Chapter 1: Recent Macroeconomic Developments  |  25 SLOW ROAD TO RECOVERY Chapter 2: Macroeconomic Outlook Weak Growth Ahead With depressed demand, uncertain export Economic activity is moderating, reflecting prospects, and significant external risks, major weaknesses in domestic demand, despite the SEE region is expected to grow at the the recovering external demand and the surge rate of 1.8 percent in 2013, broadly in line in exports. The Serbian economy is beginning with the SEE6 RER June report projection. a sizeable fiscal consolidation to bring its debt Bosnia and Herzegovina and Kosovo remain to a sustainable level and this is likely to act the slowest and the fastest growing SEE6 as a drag on activity. The economies of FYR economies, respectively. Growth prospects for Macedonia, Kosovo, and Montenegro have 2013 for FYR Macedonia and Montenegro some momentum in construction, services, and have been slightly upgraded, while downward tourism, but their shares in the regional SEE6 revisions were made for Albania, Kosovo, and economy is too modest to change the overall Serbia (Table 3). regional picture. Table 3: Economic Growth Rates 2012–14 Thus, the 2014 SEE6 economic growth percent prospects remain subdued and hinge upon 2012 2013f 2014f a sustained recovery of external demand. Albania 1.6 1.3 2.1 Overall, net exports will continue to drive growth in the short term. However, unfavorable Bosnia and Herzegovina -1.1 0.8 2.0 labor market conditions, poor investment Kosovo 2.7 3.0 4.0 climate, and subdued consumption and FYR Macedonia -0.4 2.5 3.0 investment will constrain economic activity. Montenegro -2.5 1.8 2.5 The SEE6 region is projected to grow at a rate Serbia -1.7 2.0 1.0 of 1.8 in 2014 instead of a previously projected SEE6 -0.7 1.8 1.8 2.7 percent. The main drag on regional growth Memo item: is a likely slowdown of the Serbian economy.8 Euro Area -0.6 -0.4 1.1 Serbia is now expected to grow only 1 percent Source: World Bank staff projections. Note: Weighted average. in 2014 compared to previously projected 3 percent on the back of declining private The one-time effects of the bounce-back of activity following the recession and improved 8 Downwards revision of projections for Kosovo’s growth for 2014 is weather conditions are dissipating, however. only by marginal 0.1 percentage point. Chapter 2: Macroeconomic Outlook  |  27 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 consumption and fiscal consolidation. In growth. The main external risks to the SEE6 contrast to Serbia, economic growth in the outlook related to: (i) the pace at which global other five SEE countries is expected to firm interest rates are may rise, with the expected up in 2014 and exceed the pace of economic tapering of quantitative easing in the U.S., (ii) expansion of 2013. the Euro Area recovery, and (iii) the potential impact of parent bank exit on the banking The balance of risks to this outlook is on systems of SEE6 countries. The internal risks the downside. Given that the developing and to the SEE6 outlook relate to “reform fatigue,” the emerging market economies, including the which may delay policy implementation, and SEE6, are entering a period of expected global the daunting fiscal challenges to stabilize and financial tightening, business-as-usual policy reduce public debt in several countries. Also, stance is no longer an option: policymakers lack of progress on NPL resolution, and private would be well advised to reduce macroeconomic sector arrears could adversely impact credit vulnerabilities, rebuild fiscal buffers, and recovery and growth prospects. reinvigorate structural reforms geared towards From Weak to Robust Growth: Improving Productivity and Competitiveness Beyond this difficult short-term horizon, SEE6 region still does not fare well on how can SEE6 raise their longer-term growth most comparative metrics on the structural prospects? Maintaining macroeconomic reforms. With major progress in reducing the stability remains a top policy priority: SEE6 cost of doing business, FYR Macedonia has countries, in particular those with high public started to attract modest FDI flows. The SEE6 debts, would need to step up fiscal adjustment countries have major advantages compared to and rebuild fiscal buffers, especially in view many other developing countries: their reforms of the likely rise in their sovereign borrowing are anchored in the EU-accession process and costs due to changes in international market they are located right next to one of the world’s conditions (e.g. US tapering of quantitative largest economic blocks. Furthermore, the easing). Equally important, structural reforms recent agreement between Serbia and Kosovo will have to be pursued with vigor. The nascent has heralded greater stability and security in the export-led growth is a positive development, region. Croatia’s accession to the EU (Box 3), but sustaining it will be a challenge. The SEE6 the opening of the accession process of Serbia need to improve their fiscal positions, decrease and Montenegro, as well as recent political public debts, and strengthen banking systems changes in the region, may provide a renewed while facing significant structural challenges in impetus for reforms and future prosperity for improving productivity and competitiveness, the region. The time to use that opportunity including in the areas of the investment climate, is now. the labor market, and the public sector. 28  |  Chapter 2: Macroeconomic Outlook SLOW ROAD TO RECOVERY Box 3: Implications of Croatia’s EU Accession for SEE6 Following the Croatia’s accession to the EU, the Central Europe Free Trade Agreement (CEFTA) had to be amended. On July 1, 2013, the new trade regime between the SEE6 and Croatia introduced an asymmetric trade liberalization regime. That means that the SEE6 countries retained the custom-free export preferences to the Croatian market as regulated under the EU Stabilization and Association Agreements. However, Croatian exports are subject to tariffs applied to the EU products. Current exports to CEFTA countries comprise 20 percent of total Croatian exports. In 2012, Croatia exported products worth EUR1.66 billion, twice as much as was imported from CEFTA to Croatia. Croatian companies have lost some competitive edge—the most affected being tobacco and agricultural products. For example, Agrokor Ltd. (focusing on food processing, wine and agri- business), had to transfer 18 percent of its EUR1.38 billion worth of investments into the SEE6 region (since 1993) in 2012, ahead of the Croatian accession to the EU. Serbia has experienced a rise in investments from Croatian firms in the year before accession. For the SEE6 countries, wine, beef, sugar and fish export will be limited to a certain quota, while other agricultural products will be duty- free under the EU Stabilization and Association agreement although subject to higher phytosanitary and veterinary standards harmonized with the EU. The EC has launched a discussion with CEFTA members on the Article 7 in the CEFTA Stabilization and Association Agreement, which implies mitigation of prescribed conditions and a reduction of high rates. However, it may take time for Croatia to restore to their previous level the trade flows affected by the exit from the CEFTA area, if they can be restored at all. Croatian companies that had been present in the SEE6 markets, in particular in the food industry, have transferred part of their production to SEE6 to mitigate the impact of tariff barriers. The road to robust long-term growth passes through gains in productivity and Improved Business Climate, competitiveness. In this issue of the RER, but Further Reforms Needed one such area is highlighted––improving the business environment, which will help dismantle barriers to the expansion of businesses and ease the burden on private investment. The SEE6 countries continued to remove regulatory obstacles to business. The index for the overall ease of doing business, as measured by the latest Doing Business Indicators, improved in the SEE6 countries from 60.4 in 2009 to 64.9 in 2013. The increase was larger than the EU11’s progress of 3.4 percentage points, though the SEE6 average still remained below that of the EU11. In 2013, Kosovo and FYR Macedonia recorded the largest improvements in the SEE6 region, with 9.8 and 9.1 percentage points, respectively (albeit in Kosovo these were Chapter 2: Macroeconomic Outlook  |  29 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 from a low basis compared to 2010). Albania, position from 46.6 to 55 in 2013. The SEE6 on the other hand, remained the only country progress primarily came from Kosovo and FYR in the region with a deteriorating position Macedonia, with the latter becoming a regional despite its recent marginal progress (Figure 46). leader with its position improving to 80.4 in Bosnia and Herzegovina is the worst performer 2013 with respect to the world’s best practice. in the region and needs to catch up rapidly with its neighbors if it is to attract investments However, despite this progress, further and improve its economic growth. reforms are needed to address the structural rigidities and increase the competitiveness of Figure 46: Distance to Frontier on the Ease the region. For example, resolving insolvency of Doing Business, 2009–13 remained the weakest area for the SEE6 group distance to the frontier (best practice=100) with only 2.5 percentage points of moderate 80 improvement in the ranking between 2009 75 and 2013. While all six countries made some improvements between 2009 and 2013, the 70 progress is insufficient to engender effective 65 insolvency procedures. In addition, the areas of enforcing contracts and protecting property 60 rights remained particularly burdensome 55 (Figure 47). 50 ALB BIH KOS MKD MNE SRB SEE6 EU11 Figure 47: SEE6 Distance to the Frontier in JJ 2009 JJ 2010 JJ 2011 JJ 2012 JJ 2013 the Areas of Doing Business, 2009 vs. 2013 Source: World Bank Doing Business Report, 2013. distance to the best practice (best practice=100) 100 Specific areas where the SEE6 countries 80 made most progress in the past few years include: starting a business, dealing with 60 construction permits and paying taxes. On 40 the scale of starting a business, SEE6 improved 20 its position relative to the world’s best practice from 78.8 in 2009 to 86.1 in 2013, with 0 Resolving insolvency Enforcing contracts Dealing with constr. permits Protecting investors Paying taxes Getting electr. Trading across borders Registering property Getting credit Starting a business Overall Kosovo recording the highest rate of progress among SEE6. In terms of paying taxes, five of the SEE6 countries continued closing their JJ 2009 JJ 2013 Source: World Bank Doing Business Report, 2013. gaps with the world’s best practice between 2009 and 2013, with Montenegro reporting the most and Serbia the least progress. Progress In sum, while economic growth in the SEE6 in dealing with construction permits was also region has resumed, the countries need remarkable: a gain of 8.3 percentage points to continue to strengthen their domestic between 2009 and 2013, as SEE6 improved its macroeconomic fundamentals and pursue 30  |  Chapter 2: Macroeconomic Outlook SLOW ROAD TO RECOVERY policies that boost productivity and resilience to external turmoil. Shifting from a slow export-led recovery path to a robust growth remains a key policy challenge for SEE6. The first ingredient of success is ensuring lasting and sustainable macroeconomic stability, which in SEE6 means reducing and sustaining moderate levels of fiscal deficits and debt. On the structural policy front, robust long-run growth requires productivity and competitiveness-enhancing reforms, elements of which are highlighted above, in addition to labor market and public sector reforms. Chapter 2: Macroeconomic Outlook  |  31 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Annex: Macroeconomic Indicators Table AI.1: SEE6: Select Economic Indicators and Projections, 2012–14 2012 2013f 2014f 2012 2013f 2014f Real GDP growth (percent) Unemployment rate3 (percent) Albania 1.6 1.3 2.1 Albania 13.0 12.8 Bosnia and Herzegovina -1.1 0.8 2.0 Bosnia and Herzegovina 28.0 27.5 Kosovo 2.7 3.0 4.0 Kosovo 30.9 Macedonia, FYR -0.4 2.5 3.0 Macedonia, FYR 31.0 28.8 Montenegro -2.5 1.8 2.5 Montenegro 20.0 19.2 Serbia -1.7 2.0 1.0 Serbia 24.0 24.1 Fiscal deficit (percent of GDP) Current account balance (percent of GDP) Albania -3.4 -5.9 Albania -10.9 -9.7 Bosnia and Herzegovina -2.7 -2.0 Bosnia and Herzegovina -9.6 -7.5 Kosovo -2.7 -2.4 Kosovo -7.6 -10.7 Macedonia, FYR -3.9 -4.0 Macedonia, FYR -3.1 -3.1 Montenegro -5.4 -4.3 Montenegro -18.7 -15.0 Serbia -7.6 -6.5 Serbia -10.5 -6.0 Public debt (percent of GDP) 1 External debt (percent of GDP) 4 Albania 59.4 66.2 Albania 56.6 56.9 Bosnia and Herzegovina 45.1 44.7 Bosnia and Herzegovina 53.0 54.2 Kosovo 8.4 9.7 Kosovo 7.6 7.2 Macedonia, FYR 34.3 35.5 Macedonia, FYR 67.0 66.1 Montenegro 54.0 54.2 Montenegro 119.2 113.4 Serbia 50.6 55.9 Serbia 86.2 81.0 Consumer price inflation (percent, period average) 2 1 Excludes guarantees. 2 2013 data shows period average through September except August for Albania 2.0 2.1 Bosnia and Herzegovina. 3 2013 data shows first quarter estimates for Bosnia and Herzegovina; and Bosnia and Herzegovina 2.1 0.7 second quarter for the rest. 2012 data shows annual averages. 4 2013 data shows second quarter external debt stock. Kosovo 2.5 2.2 Macedonia, FYR 3.3 3.3 Montenegro 4.1 2.9 Serbia 7.3 8.2 32  |  Annex: Macroeconomic Indicators SLOW ROAD TO RECOVERY Figure AI.1: Real GDP: Percentage Change since Pre-Crisis Peak percent change from 2008 real GDP index (2002=100) Albania 170 Bosnia and Herzegovina 160 Kosovo 150 FYR Macedonia 140 Montenegro Serbia 130 SEE6 120 EU11 110 EU15 100 -5 0 5 10 15 20 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ Albania ▬▬ Kosovo ▬▬ Montenegro ▬▬ FYR Macedonia ▬▬ Bosnia and Herzegovina ▬▬ Serbia Source: World Bank staff calculations. Figure AI.2: Real GDP Growth Projections for 2013 projected GDP growth in 2013, percent percent Albania 12.5 Bosnia and Herzegovina 10.0 Kosovo 7.5 FYR Macedonia 5.0 Montenegro 2.5 Serbia 0 SEE6 -2.5 EU11 -5.0 EU15 -7.5 -0.5 0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2002 2004 2006 2008 2010 2012 -13f -14f ▬▬ Kosovo ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ Serbia Source: World Bank staff projections. Annex: Macroeconomic Indicators  |  33 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure AI.3: Unemployment Rate H1 2013, percent of labor force (aged 15–64) percent of labor force (aged 15–64) Albania 40 Bosnia and Herzegovina 35 Kosovo FYR Macedonia 30 Montenegro 25 Serbia 20 SEE6 EU11 15 EU15 10 0 5 10 15 20 25 30 35 2006 2007 2008 2009 2010 2011 2012 H1 2013 ▬▬ FYR Macedonia QQ Kosovo ▬▬ Bosnia and Herzegovina ▬▬ Serbia ▬▬ Montenegro ▬▬ Albania Source: World Bank staff calculations. Notes: Kosovo as of 2012; Bosnia and Herzegovina as of Q1 2013. Figure AI.4: Fiscal Balance projected 2013, percent of GDP percent of GDP Albania 7.5 Bosnia and Herzegovina 5.0 Kosovo 2.5 FYR Macedonia 0 Montenegro Serbia -2.5 SEE6 -5.5 EU11 -7.5 -7 -6 -5 -4 -3 -2 -1 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ Bosnia and Herzegovina ▬▬ Kosovo ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Albania ▬▬ Serbia Source: World Bank staff calculations. 34  |  Annex: Macroeconomic Indicators SLOW ROAD TO RECOVERY Figure AI.5: Public Debt projected 2013, percent of GDP percent of GDP Albania 80 70 Bosnia and Herzegovina 60 Kosovo 50 FYR Macedonia 40 Montenegro 30 Serbia 20 10 SEE6 0 0 10 20 30 40 50 60 70 80 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ Albania ▬▬ Montenegro ▬▬ Serbia ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Kosovo Source: World Bank staff calculations. Figure AI.6: Export Growth 2012, percent of GDP annual growth, percent Albania 50 40 Bosnia and Herzegovina 30 Kosovo 20 FYR Macedonia 10 Montenegro 0 Serbia -10 SEE6 -20 -30 EU15 -40 0 10 20 30 40 50 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 H1 2013 ▬▬ Serbia ▬▬ Montenegro ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Kosovo Source: World Bank staff calculations. Annex: Macroeconomic Indicators  |  35 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Figure AI.7: Import Growth 2012, percent of GDP annual growth, percent Albania 60 Bosnia and Herzegovina 50 40 Kosovo 30 FYR Macedonia 20 Montenegro 10 Serbia 0 SEE6 -10 EU15 -20 0 10 20 30 40 50 60 70 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 H1 2013 ▬▬ Serbia ▬▬ Montenegro ▬▬ FYR Macedonia ▬▬ Kosovo ▬▬ Albania ▬▬ Bosnia and Herzegovina Source: World Bank staff calculations. Figure AI.8: Current Account Balance projected 2013, percent of GDP percent of GDP Albania 20 Bosnia and Herzegovina 10 Kosovo 0 FYR Macedonia -10 Montenegro -20 Serbia -30 SEE6 -40 EU11 -50 -20 -15 -10 -5 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ FYR Macedonia ▬▬ Serbia ▬▬ Bosnia and Herzegovina ▬▬ Albania ▬▬ Kosovo ▬▬ Montenegro Source: World Bank staff calculations. 36  |  Annex: Macroeconomic Indicators SLOW ROAD TO RECOVERY Figure AI.9: Deposit and Private Credit Growth private credit growth, percent deposit growth, percent 90 50 80 40 70 60 30 50 20 40 10 30 20 0 10 -10 0 -20 -10 -20 -30 Jun-08 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 Jun-13 Jun-08 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 Jun-13 ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Albania ▬▬ Bosnia and Herzegovina ▬▬ FYR Macedonia ▬▬ Serbia ▬▬ Kosovo ▬▬ Montenegro ▬▬ Serbia ▬▬ Kosovo ▬▬ Montenegro Source: World Bank staff calculations. Figure AI.10: Non-Performing Loans H1 2013, percent of total loans percent of total loans 25 Albania Bosnia and Herzegovina 20 Kosovo 15 FYR Macedonia 10 Montenegro 5 Serbia 0 H1 -5 0 5 10 15 20 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ Albania ▬▬ Montenegro ▬▬ Bosnia and Herzegovina ▬▬ Serbia ▬▬ FYR Macedonia ▬▬ Kosovo Source: World Bank staff calculations. Annex: Macroeconomic Indicators  |  37 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5 Table AI.2: Sovereign credit ratings Dec 2010 Dec 2011 Dec 2012 Sep 2013 ALB B+ B+ B+ B+ Bosnia and Herzegovina B+ B B B MKD BB BB BB BB- MNE BB BB BB- BB- SRB BB- BB BB- BB- Source: Standard and Poor’s. Note: Kosovo does not have a credit rating. Figure AI.11: Ease of Doing Business 2013, proximity to frontier (best practice=100) proximity to frontier (best practice=100) Albania 80 Bosnia and Herzegovina 75 70 Kosovo 65 FYR Macedonia 60 Montenegro 55 Serbia 50 SEE6 45 EU11 40 40 45 50 55 60 65 70 75 80 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ FYR Macedonia ▬▬ Montenegro ▬▬ Kosovo ▬▬ Serbia ▬▬ Albania ▬▬ Bosnia and Herzegovina Source: World Bank staff calculations. 38  |  Annex: Macroeconomic Indicators