WESTERN BALKANS REGULAR ECONOMIC REPORT No.14 | Fall 2018 Higher But Fragile Growth Western Balkans Regular Economic Report No.14 Higher But Fragile Growth Fall 2018   Acknowledgements This Regular Economic Report (RER) covers economic developments, prospects, and economic policies in the Western Balkans region: Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. The report is produced twice a year by a team led by Ekaterina Vostroknutova and Marc Tobias Schiffbauer (Task Team Leaders). This issue’s core team included World Bank staff working on the Western Balkan countries (with additional contributions to specific sections): Agim Demukaj, Sandra Hlivnjak (External section), Edith Kikoni (Fiscal section), Sanja Madžarević-Šujster (Labor section), Asli Senkal (Growth and Outlook sections), Lazar Šestović (Outlook section), Hilda Shijaku (Monetary section), Bojan Shimbov (External section), and Gunhild Berg (Financial sector section), and Christoph Ungerer (Financial Sector section and Spotlight). Additional contributions were from Michael Joseph Ferrantino, Maria Filipa Seara E Pereira, and Colin Christopher Ek (External section); Alena Kantarovich, Cevdet Cagdas Unal, Ruvejda Aliefendic, and Keler Gjika (Financial sector section); and Trang Van Nguyen, Monica Robayo, Ana Maria Oviedo, and Cesar Cancho (Labor section). The team is grateful for comments from David Gould, Stefanie Koettl-Brodmann, Josefina Posadas, and Maddalena Honorati. Anne Grant provided assistance in editing, and Budy Wirasmo assistance in designing. Valentina Aleksic, Nejme Kotere, Samra Bajramovic, Ivana Bojic, Enkelejda Karaj, Hermina Vukovic Tasic, Jasminka Sopova, Boba Vukoslavovic, Dragana Varezić, and Leah Laboy assisted the team. The dissemination of the report and external and media relations are managed by an External Communications team comprised of Lundrim Aliu, Anita Božinovska, Paul A. Clare, Ana Gjokutaj, Jasmina Hadžić, Carl P. Hanlon, Vesna Kostić, John Mackedon, Mirjana Popović, Kym Louise Smithies, and Sanja Tanić. The team is grateful to Linda Van Gelder (Regional Director for the Western Balkans); John Panzer (Director, Macroeconomics, Trade, and Investment Global Practice); Gallina A. Vincelette (Practice Manager, Macroeconomics, Trade, and Investment Global Practice); and the Western Balkans Country Management team for their guidance in preparation of this report. The team is also thankful for comments on earlier drafts of this report received from the Ministries of Finance and Central Banks in Western Balkans countries. This Western Balkans RER and previous issues may be found at www.worldbank.org/eca/wbrer/. © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Contents Higher But Fragile Growth 1. Overview 2 2.  Stronger growth, due to higher public spending 4 3.  In most countries, job creation has slowed 8 If it is to be redirected to growth, spending must be better managed 4.  13 Inflation slowly rises due to higher tax rates and prices for imported food and energy 5.  18 Lending to households drives credit growth; despite lower NPLs, corporate 6.  lending is sluggish 20 In most countries, despite export growth external deficits are still high 7.  23 8.  The growth outlook is positive, but fragile 28 Greater regional economic integration means higher growth and more jobs  9.  Spotlight:  34 Country Notes 39 Albania41 Bosnia and Herzegovina 46 Kosovo51 FYR Macedonia 56 Montenegro61 Serbia66 Key Economic Indicators 73 vi  | Contents HIGHER BUT FRAGILE GROWTH List of Figures Figure 2.1. Growth is projected to pick up across the region in 2018. 4 Figure 2.2. Higher spending supported consumption and investment growth in 2018. 4 Figure 3.1. Employment has responded slowly to growth. 8 Figure 3.2. In all Western Balkans countries except Serbia, unemployment declined in 2018. 9 Figure 3.3. Inactivity is not only high but has even increased in several countries. 9 Figure 3.4. Female labor participation is about 25 percent lower than male. 10 Figure 3.5. Higher spending supported consumption and investment growth in 2018. 11 Figure 4.1. Fiscal consolidation has substantially reduced the deficit in Montenegro. 13 Figure 4.2. Revenue gains helped finance higher spending in most of the region. 13 Figure 4.3. Higher spending went mainly to capital investment and social benefits. 14 Figure 4.4. Spending remains dominated by public wages and social programs. 14 Figure 4.5. Public debt-to-GDP ratios fell in Serbia, Albania, and Bosnia and Herzegovina. 16  xternal PPG debt increased in countries with Eurobond issues, Figure 4.6. E decreased in some others. 16 Figure 5.1. Inflation, though slowly building, is still contained. 18 Figure 5.2. Food and energy prices have been mainly driving inflation in the first half of 2018. 18 Figure 5.3. Monetary policy further eased in the economies using inflation targeting… 19 Figure 5.4. …as their currencies appreciated. 19 Figure 6.1. Credit outstanding continued to increase in most countries. 21 Figure 6.2. Credit to households grew; credit to firms dwindled. 21 Figure 6.3. Nonperforming loans are declining. 21 Figure 6.4. Banks are adequately capitalized. 21 Figure 7.1. External deficits in the region have held steady. 23 Trade in goods drove the change in CADs, helped in some countries by Figure 7.2.  new services exports. 23 Figure 7.3. Stable FDI helped finance most CADs… 25 Figure 7.4. …but overall, FDI inflows stagnated at low levels. 25  e combination of external and fiscal deficits heightens regional Figure 8.1. Th vulnerability to rising costs for financing. 29  mong small countries in Europe and Central Asia, high income per Figure 9.1. A capita is closely correlated with trade openness. 36 Contents  |  vii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 List of Tables Table B7.1.1. Composition of Western Balkan services exports. 27 Table 8.1. With growth likely to recover, the outlook is positive. 28 Channels for transmission of Turkish market volatility to Western Table B8.1.1.  Balkan countries. 30 List of Boxes Box 2.1. What kind of FDI for the Western Balkans? 6 Higher mobility, within as well as between countries, could help reduce Box 3.1.  unemployment.12 Box 4.1. Findings of the Public Investment Management Assessment. 15 Box. 7.1. Potential for value chain integration for Western Balkan exports to the EU. 25 Box. 8.1. Impact of the situation in Turkey on the Western Balkans. 29 Box 8.2. Impact of global trade tensions on the Western Balkans. 32 viii  | Contents Higher But Fragile Growth WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 1. Overview Growth in the Western Balkans has Higher private investment led to higher strengthened to an estimated 3.5 percent. economic growth. But to sustain growth, more In most of the region, growth projections for investment is needed in tradable sectors. With 2018 have been revised upward. Kosovo and competition between emerging markets fierce, Albania are expected to grow at 4 percent this investors will be attracted by political stability, year. At 3.8 percent, Montenegro’s growth a business-friendly regulatory environment, is projected to be 1 percentage point higher, quality infrastructure, and a skilled labor force. although still lower than last year. Growth in Since credit is driven mostly by household Bosnia and Herzegovina continues to be stable borrowing, a more diversified and growth- at an estimated 3.2 percent. Serbia’s economy friendly financial sector would also help to has rebounded to 3.5 percent growth after last attract domestic and foreign investors. year’s weather-related slowdown. Macedonia’s Higher exports are also necessary for more growth also rebounded to 2.5 percent, as secure long-term growth. External imbalances investor confidence was restored. have been high but mostly stable. Bosnia and Growth was stimulated by higher public Herzegovina, Macedonia, and Serbia have investment and consumption. Driven by tax all seen their exports grow fast. But growing reforms and faster growth, higher tax revenues consumption and large infrastructure projects created fiscal space, which some countries have pushed up imports. Sustainably higher rushed to use for current spending and capital exports will help maintain macroeconomic investment. Greater public investment is a stability, contribute to growth, and reduce welcome sign, but to be successful it must poverty. Support could also come from regional be supported by more efficient and effective integration: Because most exports of Western public spending. The surge in untargeted Balkan countries do not compete with each social spending and public wages has had an other, the benefits from regional integration immediate effect on growth rates in several into European Union value chains can be countries through faster growth in consumption significant—and without trade-offs. The Multi- and household credit. But such effects are Annual Action Plan for building a regional temporary and costly to sustain: in the longer economic area is a step in the right direction. term they heighten fiscal vulnerability. The risks clouding a positive growth outlook Over 90,000 jobs were created in the first are both external and internal. A possible half of 2018, with new employment mostly tightening of the financing conditions in in industry and services. But the overall labor international capital markets is a downside market response to growth was slower than it risk, especially in countries that have external could have been, reflecting the temporary nature and fiscal imbalances. With domestic sovereign of consumption-led stimuli as well as a rise in bond markets often underdeveloped, Western labor inactivity. In some countries, inactivity Balkan countries are exposed to rises in and emigration rather than new job creation global interest rates. Robust growth in the explain the fall in unemployment. Structural region also depends heavily on domestic and distortions in labor markets find expression regional political stability, which define the in high regional and gender disparities in speed of structural reforms. Mitigating these outcomes. Improving incentives to participate external and internal risks requires both a in the labor force will help stimulate both job firm commitment to fiscal consolidation and creation and growth. acceleration of structural reforms. Countries with higher growth rates boosted them mostly by investment and exports. 2  |  1. Overview HIGHER BUT FRAGILE GROWTH Growth in the region strengthened...  …due to higher public spending.  Real GDP growth, percent Contribution to change in public expenditure, 2018 estimate, percent of GDP 5 4 4.0 4.0 3 4 3.8 3.5 3.5 3.2 2 3 2.5 1 2.1 2 0 1 -1 0 -2 KOS ALB MNE SRB BIH MKD WB6 EU28 BIH KOS MKD ALB SRB MNE WB6 JJ 2016 JJ 2017 JJ 2018e JJ Wage bill JJ Social benefits JJ Capital expenditures QQ Total expenditures  ut limited private sector dynamism is B  …and in low, stagnant FDI inflows. reflected in the slow response of employment… Two-quarter average y-o-y employment growth, percent Net FDI to GDP, percent 12 20 12 6 10 10 5 15 8 8 4 6 10 6 3 4 4 2 5 2 2 1 0 0 0 0 -2 -2 -1 -5 -4 -4 -2 -6 -10 -6 -3 -15 -15 -16 -16 -16 -16 -17 -17 -17 -17 -18 -18 Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun MNE ALB SRB MKD KOS BIH WB6 ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ KOS, rhs …… WB6 JJ Net FDI to GDP 2018e QQ 2017–18e change in net FDI to GDP, pps, rhs nstead, high and rising PPG debt is coupled I …  making the outlook vulnerable to tightening with fiscal and external imbalances… in financial markets, protectionism, and domestic politics. Public and publicly guaranteed debt, percent of GDP Growth rates, 2017–2020f, percent 80 2017 2018e 2019f 2020f 70 Albania 3.8 4.0 3.6 3.5 60 Bosnia and Herzegovina 3.0 3.2 3.4 3.9 50 Kosovo 3.7 4.0 4.5 4.5 40 Macedonia, FYR 0.0 2.5 2.9 3.2 30 Montenegro 4.3 3.8 2.8 2.5 20 Serbia 1.9 3.5 3.5 4.0 10 WB6 2.4 3.5 3.5 3.8 0 MNE ALB SRB MKD BIH KOS WB6 JJ 2018e ▬▬ 2017 QQ 2007 1. Overview  |  3 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 2.  Stronger growth, due to higher public spending In the Western Balkans growth is projected investment. In Kosovo and Albania, growth to accelerate, reaching 3.5 percent for 2018 is expected to reach 4 percent. In Kosovo, (Figure 2.1). In most of the region growth will be  it is driven by a rebound in consumption, a higher in 2018 than it was in 2017. The growth rise in transport infrastructure investment, projection for Serbia, the largest economy in the and higher exports of services. Albania is region, has been revised upward to 3.5 percent, benefiting from a doubling in hydro energy supported by a rise in both public and private production thanks to strong rainfall, a solid tourism season that boosted services exports, Figure 2.1. Growth is projected to pick up and a pick-up in manufacturing. In Bosnia and across the region in 2018. Herzegovina, growth continues to be a steady Percent 3.2 percent, driven primarily by consumption 5 and an increase in public investment. Growth 4 4.0 4.0 3.8 in FYR Macedonia is expected to rebound to 3.5 3.5 3.2 2.5 percent, supported by improved investor 3 2.5 confidence and rise in consumption and 2.1 exports. Although growth in Montenegro is 2 projected to be slightly lower than last year, 1 it remains strong at 3.8 percent, 1 percentage point (pp) faster than projected earlier, due to 0 energy and tourism investments and a speed-up KOS ALB MNE SRB BIH MKD WB6 EU28 JJ 2016 JJ 2017 JJ 2018e in construction of the Bar-Boljare highway. Source: National statistical offices data; Eurostat; World Bank staff estimates. Note: Data for WB6 and EU28 calculated as weighted average. Figure 2.2. Higher spending supported consumption and investment growth in 2018. Factors in real GDP growth, percent 2017 2018e 9 5 7 4 5 3 3 2 1 1 -1 0 -3 -1 -5 -2 ALB KOS MNE SRB BIH MKD ALB KOS MNE SRB BIH MKD JJ Consumption JJ Investment JJ Net exports QQ Real GDP growth JJ Consumption JJ Investment JJ Net exports QQ Real GDP growth Source: National statistical offices; World Bank estimates. 4  |  2. Stronger growth, due to higher public spending HIGHER BUT FRAGILE GROWTH In 2018 consumption continues to underpin a strong tourism season, and a slowing in economic activity, supported by growth in imports as import-intensive FDI projects near wages and employment  (Figure 2.2). The completion. Although lower than last year, increase in consumption has been supported net exports are also expected to contribute by consumer borrowing, higher social transfers, 0.4 pp to growth in Kosovo, despite the halt in public wages, and employment. For example, Ferronikeli production, due to higher tourism- FYR Macedonia increased public support related services. In FYR Macedonia also, the through the employment program and expanded contribution of net exports is expected to be pension spending. Bosnia and Herzegovina and positive, adding 0.7 pp to growth in 2018, Kosovo increased social spending and public due to a solid performance by car industry wages. In 2017 Albania, FYR Macedonia, and suppliers. In Bosnia and Herzegovina and Serbia increased the minimum wage. The rise Serbia, fast growth in imports is overshadowing in untargeted social spending may have spurred a solid increase in exports, so that net exports consumption in some countries, but it also are projected to subtract about 1 pp from raises fiscal sustainability concerns. growth. Similarly, in Montenegro, net exports are expected to continue to subtract from In all six countries higher public investment growth as strong tourism and exports of is expected to make a positive contribution electricity, aluminum, and steel are offset by to growth. Investment growth in general higher imports of intermediate goods for the continues to be robust. It is projected to add construction of the Bar-Boljare highway. 2.7 pp to growth in Montenegro, 2.1 pp in Kosovo, 1.7 pp in Serbia, and 1.5 pp in To speed up growth in the region and Albania. Investment growth is driven by higher make it more sustainable will require both public capital spending in all countries but more investment and more exports. The FYR Macedonia. The increase in public higher pace of growth is much needed in investment is compensating for the decline the Western Balkans, but now it needs to be in foreign direct investment (FDI) in Kosovo sustained. Higher public investment may be a and in Albania, where FDI-financed energy welcome sign, but they must be supported by projects are near completion. In Montenegro more efficient and effective public spending and Serbia, the rise in public capital spending if public investment programs are to succeed. is accompanied by an increase in private Stimulating growth through consumption and investment. In FYR Macedonia, by mid-2018 untargeted social spending may give temporary private investment in construction had also growth benefit but is hardly sustainable. started to grow, after 12 consecutive months of Moreover, such an approach will raise fiscal and decline. external vulnerability and may exacerbate the already high debt of Western Balkan countries. The contribution of net exports to growth Private investment and increased export growth is projected to recover somewhat from last have elsewhere proved to be sure and sustainable year, but it will still be minimal. Net exports drivers of long-term growth. But investment are contributing most in Albania, where they in the region, which averaged 23 percent in are expected to add 1 pp, thanks to a weather- 2009–16, is far below the 31 percent average related spike in exports of hydroelectric power, for upper-middle-income countries (UMICs). 2. Stronger growth, due to higher public spending  |  5 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 As public investment grows, there is also ample (Box 2.1). While higher exports are doing more room to push up private investment. Building to support growth in most Western Balkan up the financial sector to increase domestic countries, their incomplete trade integration— savings and attract FDI to the tradable sectors average exports within the region are only of the economy would benefit the region by about 40 percent of GDP—limits their growth reinforcing the long-term sustainability of its potential (see the Spotlight discussion in growth. This will also require structural reforms Section 9). Box 2.1. What kind of FDI for the Western Balkans? FDI can facilitate economic growth through productivity spillovers, job creation, and upgrading of the export basket. Technology transfers through FDI to domestic suppliers, downstream sectors, or competitors are thought to have contributed considerably to technology adoption, structural change, and job creation in many East Asian economies, among them China, India, and Malaysia. Policymakers in developing economies often provide incentives to attract FDI in the expectation that it brings in not only capital but also new technologies, marketing techniques, and management skills. In fact, FDI is considered a major channel for transfers of technology to developing countries. Spillovers occur when local firms copy technologies either through observation or by hiring workers trained by companies with foreign parents. FDI in backbone service sectors has also been seen to raise the quality of the services offered. But not all FDI are equally effective in speeding up growth. Analysis of sectors receiving FDI provides information about the productivity potential of technology spillovers through backward links to domestic suppliers or forward links to domestic industries. FDI in car manufacturing, for instance, has been shown over time to provide productivity spillovers to domestic suppliers of car parts. Similarly, productivity spillovers have been associated with FDI in backbone service sectors like ICT, finance, or hotels and tourism, and downstream in manufacturing. Investments in real estate and mining, however, have few links with the domestic economy, especially once construction ends, and little potential for productivity spillovers. Foreign direct investment (FDI) in the Western Balkans is quite limited. The average FDI stock per capita in the Western Balkans (€2,600 in 2015) is less than half of the FDI stock per capita in Eastern European EU members, and just one-seventh of the EU average. Montenegro has the highest FDI stock per capita (€6,700), followed by Serbia (€3,700), which has enjoyed fast growth in greenfield FDI. FDI stock per capita of the other Western Balkan countries is at €2,000 or less. In FYR Macedonia and Kosovo, except for a few exceptional years, net FDI flows have been mostly below 5 percent of GDP. In Albania, net FDI, mainly for hydropower projects, reached 9 percent of GDP in 2017. In Serbia, between 2009 and 2017 annual FDI inflows averaged 5 percent of GDP. In the same period, FDI in Montenegro, though quite volatile, averaged 15 percent of GDP but mainly targeted tourism and real estate. Greenfield FDI in the Western Balkans has mainly originated from EU-28 countries like Italy, Austria, Germany, Slovenia, and the Netherlands, but also contributing were investors from Russia, the United Arab Emirates, the USA, and Turkey. Similarly, when all FDI stock is considered, 6  |  2. Stronger growth, due to higher public spending HIGHER BUT FRAGILE GROWTH Box 2.1 continued most originates in the Netherlands, Austria, Cyprus, Greece, Italy, and Switzerland. Intra-regional FDI is quite limited, which suggests that there is room for regional integration. The concentration of Western Balkans FDI in real estate and energy extractives suggests that in the region FDI contributes little to productivity growth, technology adoption, or formal job creation. Real estate accounted for 20 percent of greenfield investment in the Western Balkans, followed by renewable energy (16 percent), and coal (14 percent). Automotive components and original equipment manufacturing, which have greater productivity spillover potential, account for only 6 percent of FDI. Because FYR Macedonia and Serbia receive the largest shares of manufacturing FDI, which goes into areas like automotive components and food products, they are better positioned to benefit from long-term productivity spillovers from foreign companies to domestic suppliers. Among factors that foreign investors consider in their investment decisions are political stability and security, a business-friendly legal and regulatory environment, infrastructure quality, labor talent and skill, and low costs for labor and inputs. But, while some Western Balkan countries make extensive use of tax holidays to attract FDI, these are typically not among the top five considerations of foreign investors in the region—only one in five investors considers that the absence of investment incentives as critically important. There is, however, evidence that countries can maximize the benefits of FDI only if they have well-developed financial markets. And investors strongly value the quality of local suppliers. The availability of human capital is central to repatriating the benefits of FDI. Improving the business environment and investing in human capital are thus a priority for attracting and maximizing the benefits from FDI in the Western Balkans. Figure B2.1.1. The composition of greenfield FDI inflows by country. Percent MNE KOS MKD BIH ALB SRB 0 10 20 30 40 50 60 70 80 90 100 JJ Real estate JJ Alternative/renewable energy JJ Other manufacturing JJ Food and tobacco JJ Coal, oil and natural gas JJ Hotels and tourism JJ Communications and financial services JJ Other services JJ Automotive components/OEM JJ Building and construction materials Source: FDImarkets and World Bank staff calculations. See also Arnold, J., B. Javorcik, M. Lipscomb, and A. Mattoo, 2012, “Services Reform and Manufacturing Performance - Evidence from India,” Policy Research Working Paper 5948, World Bank, Washington, DC; Javorcik, B., 2004, “Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers through Backward Linkages”, American Economic Review 94 (3): 605-627; and Rodrik, Dani, 2008, “Normalizing Industrial Policy,” Commission on Growth and Development Working Paper 3, World Bank, Washington, DC; Jirasavetakul, L. F., J. Rahman, 2018, “Foreign Direct Investment in New Member State of the EU and Western Balkans: Taking Stock and Assessing Prospects”, WP/18/187International Monetary Fund, Washington DC. 2. Stronger growth, due to higher public spending  |  7 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 3.  In most countries, job creation has slowed Employment rose in all countries except manufacturing were largely in FDI companies, Kosovo but more slowly than in 2017. Only which benefit from tax exemptions, employment 91,400 new jobs were created in the Western subsidies, and other government support. Balkans in the first half of the year, compared In Montenegro, not only manufacturing to 214,000 a year ago. Looking at the half-year and construction but also tourism and the y-o-y changes, employment growth slowed in public sector were significant contributors to all countries except Albania, which gained from employment growth. Employment in Kosovo higher female participation in the labor market. declined in manufacturing, agriculture, In Montenegro, 2.2 percent employment accommodations, and mining but rose in trade, growth was led by construction and tourism, information and communication technology reaching 48.1 percent in June 2018. In Kosovo, (ICT), and the public sector. employment contracted by 3.1 percent in the first half of 2018, after steep increases in 2016 Figure 3.1. Employment has responded slowly and 2017. At 48.6 percent, Serbia registered a to growth. historically high employment rate in June 2018, Two-quarter average y-o-y employment growth, percent 12 20 as employment grew by 0.9 percent y-o-y in 10 the first half of 2018. Employment growth was 8 15 about the same in Bosnia and Herzegovina and 6 10 led the employment rate to rise to 34.3 percent 4 5 in 2018. In FYR Macedonia, employment 2 grew by 2.1 percent, supported by the 0 0 employment subsidy program. With across- -2 -5 the-board improvements in the labor market, -4 by June 2018 Albania had employment growth -6 -10 -15 -15 -16 -16 -16 -16 -17 -17 -17 -17 -18 -18 of 4.1 percent y-o-y. It also had the highest Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE employment rate in the Western Balkans at ▬▬ SRB ▬▬ KOS, rhs …… WB6 52 percent, up by 2 pp from a year earlier, and Source: National statistics offices and World Bank staff estimates. the lowest youth unemployment. In most Western Balkan countries, Most of the new jobs are in industry or unemployment hit a new low, and a services. As structural change continues, the total of 9,000 unemployed young people availability of jobs in agriculture is declining found jobs. By June 2018, unemployment across the region. In Albania and Bosnia and declined to historical lows of 21.1 percent in Herzegovina, employment growth originated FYR Macedonia, 14.4 percent in Montenegro, in services and industry. Similarly, most new 12.4 percent in Albania and 11.9 percent in jobs in FYR Macedonia were in manufacturing, Serbia. Although by June there was an overall food, and accommodation services, followed by y-o-y decline in unemployment in Kosovo (by the recovering construction sector. The gains in 1.2 pp) and Bosnia and Herzegovina (2.1 pp), 8  |  3. In most countries, job creation has slowed HIGHER BUT FRAGILE GROWTH Figure 3.2. In all Western Balkans countries Figure 3.3. Inactivity is not only high but has except Serbia, unemployment declined in even increased in several countries. 2018. Unemployment rate, 15+ years, percent, and 2017–2018 Inactivity rate, 15+ years, percent, and 2017–2018 change, pp change, pp -0.9 -0.2 WB6 WB6 0.1 -1.2 SRB ALB -1.5 0.3 ALB MKD -0.7 -0.7 MNE SRB -2.1 -1.4 BIH MNE -1.4 0.6 MKD BIH -1.2 2.6 KOS KOS 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 20 24 28 32 36 40 44 48 52 56 60 JJ June 2018 JJ June 2017 JJ June 2018 JJ June 2017 Source: National statistics offices and World Bank staff estimates. Source: National statistics offices and World Bank staff estimates. this was mainly due to lower participation support job creation. In most of the region rates. By mid-2018 youth unemployment inactivity recently increased, suggesting that in the region had also declined to a historic more people transitioned from unemployment low, 35.9 percent. It was lowest in Albania to inactivity than found jobs (Figures 3.2 at 22.6 percent, followed by Montenegro and 3.3). In contrast to the regional trend, in at 23.9 percent. Elsewhere in the Western Albania and Serbia sustained growth supported Balkans, youth unemployment ranged job creation and encouraged labor force from 27 percent in Serbia to 55 percent in participation. The overall participation rate for Kosovo. Youth unemployment actually rose, the Western Balkans improved to 54.4 percent however, in Kosovo and FYR Macedonia. In in June 2018, up by 1.2 percentage points from Montenegro, even with unemployment at an a year earlier, with participation in Albania all-time low, more than half of Montenegrins of rising above 59 percent. In some countries, working-age still have no jobs. Despite recent emigration might have also played a role in improvements, and suggestive of pervasive reduction of the labor force. structural constraints in the labor market, over 70 percent of the unemployed have been Despite some improvement, labor force looking for a job for over a year in Kosovo, participation of women continues to be low about 78 percent in FYR Macedonia, and across the region. In Albania the participation 80 percent in Bosnia and Herzegovina. of women in the labor force shot up to 51.4 percent in June 2018 (Figure 3.4). For Except in Albania and Serbia, the decline in Albanian women aged 25–54 it has improved unemployment was partly due to a rise in to 75 percent, narrowing the gender gap to inactivity. In June 2018, the inactivity rate in 15 pp. Serbia and Montenegro also have female the Western Balkans was still a high 46 percent, participation rates above the regional median despite years of growth and direct attempts to of 46 percent. In Montenegro, the gender 3. In most countries, job creation has slowed  |  9 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 gap is narrowest—14 pp; now that lifetime desperately needs and thus reduce potential benefits to mothers of three or more children growth rates. have been abolished, over the medium term the female participation rate is likely to rise. In With inflation still low, growth, job creation, Bosnia and Herzegovina, however, by mid-year and wage growth have been lifting people female labor force participation had fallen to out of poverty. In 2017, the average poverty 31.4 percent. rate for Albania, Kosovo, FYR Macedonia, Montenegro, and Serbia dropped by an Figure 3.4. Female labor participation is about estimated 1 pp from a year earlier, to a projected 25 percent lower than male. regional poverty rate of 23.1 percent. But rising Labor force participation, percent, 2015 and June 2018 inflation, especially in food and energy prices, 80 is starting to affect lower-income households 70 where food consumes more of the household 60 budget. In this regard, moderate minimum wage 50 increases that keep up with productivity growth 40 and inflation, such as a 4.3 percent increase in 30 Serbia, have been helpful in supporting the 20 poor. In Albania, the increase in the minimum 10 wage and higher capacity utilization in labor- 0 intensive agriculture and construction pushed ALB SRB MNE MKD BIH KOS QQ Female LFP QQ Male LFP ▬▬ 2015 ▬▬ June 2018 up wages. In the first quarter of 2018 real Source: National statistics offices and World Bank staff estimates. wages increased by 2.3 percent; they went up faster for women than for men, narrowing the High inactivity among the working-age gender gap. In FYR Macedonia, in the first population means that a large share of factors half of the year net wages grew nominally by of production and sources of income remains 5.5 percent y-o-y—and by over 10 percent untapped, slowing economic growth. The in low-wage labor-intensive sectors. While working-age dependency ratio in the Western this has likely helped reduce poverty, labor- Balkans is extremely high—2.24 in 2017; this intensive industries, such as textiles, have means that on average a working adult supports asked the government to subsidize costs to 2.24 dependents of working-age (Figure 3.5). avoid layoffs. In other words, about 134,000 The high dependency ratio places a greater people escaped poverty during 2016–17.1 To burden on workers and the government to sustain recent welfare improvements, countries support the unengaged. It also exacerbates the across the region will need to continue creating existing disincentives to work and, given aging, jobs to sustainably boost labor earnings. For implies a shrinking labor force. Oversized the minimum wage to remain a functioning public sectors in some countries, plentiful instrument of labor market policy, to avoid a options for early retirement, and high social surge in informal employment, and to maintain benefit disincentives for engaging in the labor market keep labor force participation rates low. All these preclude the emergence of the 1 Poverty figures reflect the upper-middle-income-country standardized benchmark of living on less than US$5 a day in 2011 skilled and adaptable labor force that the region PPP terms. 10  |  3. In most countries, job creation has slowed HIGHER BUT FRAGILE GROWTH Figure 3.5. Higher spending supported consumption and investment growth in 2018. Structure of the working age population aged 15+ in the Western Balkans of which Employed youth 0.5 million (3.5%) Employed 6.3 million (44.7%) of which in public sector Active labor force 1.6 million (11.3%) 7.4 million (52.5%) of which Working age Unemployed Unemployed youth population 15+ 1.1 million (7.8%) 0.3 million (2.1%) 14.1 million of which Inactive labor force Pensioners 6.7 million (47.5%) 3.5 million Source: National statistical offices and World Bank staff estimates. cost competitiveness, minimum wage policy in Bosnia and Herzegovina, FYR Macedonia, should be informed by the degree of labor and Montenegro. The fact that labor-intensive productivity in the sectors where it mostly sectors like tourism and construction drove applies. growth in Montenegro could reflect low labor mobility or weak links between tourism and Since employment has not consistently domestic suppliers of services and goods (Box tracked growth, the Western Balkans need 3.1). Clearly, it is necessary to dismantle both to address structural rigidities that affect the barriers that prevent the domestic working- labor market and delay formalization. In the age population from taking formal jobs last decade in several countries, the elasticity and regulatory barriers to firm entry and of employment growth to GDP growth was competition in high-growth sectors and their minimal. Past GDP growth was not highly suppliers. correlated with subsequent employment growth 3. In most countries, job creation has slowed  |  11 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Box 3.1. Higher mobility, within as well as between countries, could help reduce unemployment. Regional differences in unemployment are significant not only between Western Balkan countries but also within each. Unemployment ranges from 11.9 percent in Serbia to about 29 percent in Kosovo. But within country differences are even starker: for instance, in Montenegro unemployment ranges from 3.2 percent in the coastal region to close to 30.8 percent in the north (Figure B3.1.1). Unemployment in the Montenegrin north is thus 11 times higher than in coastal areas; even the central region, which is within commuting distance of the coast, has triple the coast unemployment rate. Yet although tourism employment is growing, internal migration is too low to fill all the jobs. In FYR Macedonia, the closer a district is to Greece and Bulgaria, the lower the unemployment rate. In Serbia, unemployment is worse in the south and east than in the north. Meanwhile, Belgrade has labor shortages in transport and construction. Low labor mobility exacerbates frictions in the labor market, and such frictions could become increasingly more binding,  making it difficult for value chains (between, e.g., services and manufacturing) to function properly and thus potentially holding back long-term industry-level productivity increases and overall economic growth. Figure B3.1.1. Unemployment hot spots. Unemployment rates, percent, June 2018 or the latest available 40 30 20 10 0 MNE Coastal ALB Diber ALB Korce SRB Vojvodina SRB Belgrade MNE Central ALB Elbasan ALB Berat ALB Gjirokaster ALB Kukes ALB Fier MKD Southeast ALB Shkoder SRB South ALB Tirane SRB South and East ALB Lezhe MKD Skopje ALB Vlore MKD Polog SRB Sumadija and West ALB Durres MKD East MKD Pelagonia MKD Vardar MKD Southwest MNE Northern MKD Northeast Source: National statistical offices. 12  |  3. In most countries, job creation has slowed HIGHER BUT FRAGILE GROWTH If it is to be redirected to growth, spending must be 4.  better managed Though past and recent fiscal consolidation moved from surplus to deficit; a 2.4 percent has borne fruit in most countries, Kosovo’s of GDP rise in spending, partly related to fiscal balance is succumbing to spending looming elections, is expected to push the pressures. In Montenegro, after a decisive fiscal deficit to 0.5 percent of GDP. Serbia’s fiscal consolidation—which abolished mothers’ fiscal position remains in surplus as interest benefits, partially froze public-sector wages, and payments and activated guarantees decline and hiked excise duties and VAT—the fiscal deficit revenue performance is strong. In Albania, the fell from 5.4 percent of GDP in 2017 to a fiscal balance is forecast to remain unchanged projected 2.2 percent in 2018. FYR Macedonia this year. is also expected to lower its deficit, from 2.8 percent in 2017 to 2.6 percent, and while Revenues continue to grow, driven by tax much of the improvement is attributable to the reform and heightened economic activity. higher revenues accompanying the economic Revenue-to-GDP ratios are projected to rebound, it is also a result of continued increase in Montenegro (2.1 pp of GDP), compression of capital spending. In contrast, FYR Macedonia (1.1 pp), and Bosnia and in Kosovo the fiscal position has worsened, Herzegovina (0.8 pp), with smaller gains partly due to a growth-enhancing rise in in Kosovo and Albania. In Serbia, although capital spending, but mainly because current healthy economic activity is supporting spending is surging as the government ramps nominal revenue gains, there has been a up untargeted social spending and public slight decline in the revenue-to-GDP ratio wages. Similarly, Bosnia and Herzegovina has (see Figure 4.2). Government revenue in Figure 4.1. Fiscal consolidation has Figure 4.2. Revenue gains helped finance substantially reduced the deficit in Montenegro. higher spending in most of the region. Fiscal deficits, percent of GDP Contribution to change in the fiscal deficit, 2018e, percent of GDP 6 4 é Reduced revenues, increased spending 5 3 4 2 3 1 2 0 1 -1 0 -1 -2 -2 -3 -3 -4 ê Increased revenues, reduced spending MKD KOS MNE ALB BIH SRB WB6 BIH KOS SRB ALB MKD MNE WB6 JJ 2016 JJ 2017 JJ 2018e JJ Expenditure JJ Revenue QQ Change in fiscal deficit Sources: National statistical offices and Ministries of Finance; World Bank estimates. Note: Data for FYR Macedonia presented in this section excludes finances of the Roads Agency (which average 1.7 percent of GDP in spending and 1 percent in revenue annually) the agency was taken off-budget in 2013. Unless otherwise specified, the regional average as calculated is not weighted. 4. If it is to be redirected to growth, spending must be better managed  |  13 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Montenegro continues to benefit from 2017’s in capital spending dominated by construction comprehensive tax reforms, among them of the Bar-Boljare highway and transfers to raising the VAT rate, reducing exemptions the health sector, consolidation reforms in and excise taxes, and introducing a new excise Montenegro continue to lower total spending. on coal. Similarly, in Bosnia and Herzegovina In Bosnia and Herzegovina, this year’s higher the February 2018 increase in excise taxes on spending mainly reflects accelerated work on oil derivatives and introduction of a road tax capital infrastructure and other investment and a tax on liquid gas have together boosted projects, the financing of which had been government revenues. In Albania, projected delayed in 2017; it also reflects recent rises in 2018 revenue gains of 0.3 percent of GDP wages and social transfers. In Kosovo, higher result from higher social security contributions spending on capital investment would be and national tax revenues, which compensate welcome except that pensions and benefits to for lower than expected VAT revenues and war veterans have been rising unsustainably. delays in introducing the new property tax. In Higher spending in FYR Macedonia has been January FYR Macedonia raised excises on diesel largely directed to health, pensions, subsidies, and heating oil. and social assistance, with capital spending declining. Nearly all countries have increased capital spending but only Montenegro and Serbia Though acceleration of large public have also scaled back total spending as a investment projects is welcome, more is not share of GDP ( Figures 4.3 and 4.4). Higher always better. Under-investment, public as well revenues have expanded the fiscal space, and as private, is an impediment to growth in all all regional economies except Serbia and Western Balkan countries. Each has established Montenegro have seen total spending rise as a single pipeline of public investment projects a share of GDP. Despite a significant increase to identify priorities and seek financing for Figure 4.3. Higher spending went mainly to Figure 4.4. Spending remains dominated by capital investment and social benefits. public wages and social programs. Contribution to change in public spending, 2018e, Estimated public spending, 2017 and 2018e, percent of GDP percent of GDP 4 50 3 40 2 30 1 20 0 10 -1 2018e 2018e 2018e 2018e 2018e 2018e 2018e 2017 2017 2017 2017 2017 2017 2017 -2 0 BIH KOS MKD ALB SRB MNE WB6 MNE BIH SRB MKD ALB KOS WB6 JJ Wage bill JJ Social benefits JJ Wage bill JJ Social benefits JJ Capital expenditures QQ Total expenditures JJ Capital expenditures QQ Total expenditures Sources: National statistical offices and Ministries of Finance; World Bank estimates. 14  |  4. If it is to be redirected to growth, spending must be better managed HIGHER BUT FRAGILE GROWTH projects to tackle infrastructure gaps. The are rigorous and transparent arrangements for scale and focus of national project pipelines appraisal, selection, and approval of investment vary significantly but improving transport projects and reinforcement of the institutions infrastructure—especially roads and railways— that fund, manage, and monitor projects. On and upgrading energy-generation capacity are average, public investment management in the popular goals throughout the region. The total Western Balkans is only about 70 percent of cost of priority projects is also reported to vary that in transition economies that are now EU substantially, from about 7 percent of GDP in members. Structural reforms to increase the Serbia to 20 percent in Bosnia and Herzegovina efficiency and productivity of public investment and 70 percent in Montenegro. However, the are vital. Western Balkan countries need to address the legacies not only of severe underinvestment In countries where consolidation is mature, but also of neglected maintenance and poor debt continues to fall; in the others, public project selection and construction. The and publicly-guaranteed (PPG) debt has findings from Public Investment Management edged up ( Figure 4.5). The combination in Assessments (PIMAs) and Public Expenditure 2017 and 2018 of economic growth, fiscal and Financial Accountability (PEFAs) carried consolidation, and active debt management out for Western Balkan countries illuminate reduced the share of PPG debt in Serbia, the significant need for better management Albania, and Bosnia and Herzegovina; in of public investments (Box 4.1). Also needed Serbia, fiscal surplus, economic recovery and Box 4.1. Findings of the Public Investment Management Assessment. Reports of Public Investment Management Assessments (PIMAs) indicate that there is considerable room for improvement to heighten the efficiency and productivity of public investment in all Western Balkan countries. For instance: • Public institutions are fragmented, with overlapping mandates and little coordination. • Project selection criteria are not systematically applied and are often waived. • Project pipelines, primarily used for Western Balkans Infrastructure Framework–funded projects, are often not part of the medium-term budget, leaving room for a proliferation of other projects in the budget that are not yet ready for work to begin. • Because there is little coordination between central government and municipalities, allocation of capital spending is distorted. • Although public procurement laws, including e-procurement, are well-designed and procedures are competitive and transparent, compliance is rare. • Monitoring and disclosure of the financial performance, investment plans, and fiscal risks of state-owned enterprises (SOEs) are limited or nonexistent. • There are substantial gaps in government budgets, largely because they do not cover the capital spending of SOEs. • Governments generally do not undertake ex post assessments and audits of projects, or do so only infrequently, for donor-funded projects. Source: Based on IMF PIMA reports for Albania (June 2016), Kosovo (April 2016 and June 2017), and Serbia (April 2016). 4. If it is to be redirected to growth, spending must be better managed  |  15 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 exchange rate dynamics have helped to reduce rise to 59 percent of GDP. In FYR Macedonia, public debt as a share of GDP from 62.5 to issuance of a €500 million Eurobond has the 58.4 percent projected by yearend. Based pushed up the general government external on an April liability management operation, debt-to-GDP ratio, which is projected to rise Montenegro’s total PPG debt, pushed up past 36 percent of GDP. External PPG debt has by financing for highway construction, is declined in other Western Balkan countries. projected to reach 74.6 percent by yearend. In Albania, exchange rate appreciation is In FYR Macedonia, due to a new Eurobond expected to keep the external debt-to-GDP issue PPG debt rose from 47.6 to a projected ratio slightly lower than last year, though 50.6 percent of GDP. Kosovo’s PPG debt, external financing is expected to increase by though the lowest in the region (16.6 percent of yearend. The decline in external PPG debt as a GDP in 2017), has continued to go up due to share of GDP in Kosovo is attributed to weak higher social benefits and improved execution execution on capital projects on loans financed of public investment projects; it is dominated by international financial institutions (IFI) and by an increase in domestic debt. continued repayment of IBRD debt inherited from the former Yugoslavia. However, as IFI External PPG debt ratios have risen in and US$-loan financing of capital and highway countries that took advantage of benign projects picks up in 2019, external PPG debt is conditions in international financial markets expected to rise with possible appreciation of (Figure 4.6). Montenegro issued a €500 million  the US dollar. Eurobond and took a €250 million syndicated loan to refinance debt totaling €360 million These developments highlight the that will come due in 2019–21 and also to importance of sound fiscal policy in the cover its financial needs for the rest of 2018 region to create the fiscal space necessary and 2019. Its external PPG debt is expected to to be able to respond to adverse economic Figure 4.5. Public debt-to-GDP ratios fell in Figure 4.6. External PPG debt increased in Serbia, Albania, and Bosnia and Herzegovina. countries with Eurobond issues, decreased in some others. Public and publicly guaranteed debt, percent of GDP External PPG debt as a percent of GDP, and percent change in total external PPG debt, 2018e 80 65 9 55 70 45 6 60 35 25 3 50 15 5 40 0 -5 30 -15 -25 -3 20 -35 -45 -6 10 -55 0 -65 -9 MNE ALB SRB MKD BIH KOS WB6 MNE SRB MKD ALB BIH KOS WB6 JJ 2018e ▬▬ 2017 QQ 2007 JJ External PPG debt, % of GDP QQ Change in total PPG external debt, %, rhs Sources: National statistical offices and Ministries of Finance; World Bank estimates. 16  |  4. If it is to be redirected to growth, spending must be better managed HIGHER BUT FRAGILE GROWTH shocks and to navigate high external risks. The possibility of the tightening of financing conditions in international capital markets and the Western Balkan’s high external imbalances call for timely measures to reduce public debt. Increasing pressures from citizens across the region demanding higher-quality public services further call for measures to create the necessary fiscal space to finance better public services. Addressing these fiscal challenges depends on adoption of medium- term fiscal consolidation strategies, increasing the efficiency of public spending, strengthening public financial management systems, and making public finances more transparent and accountable. 4. If it is to be redirected to growth, spending must be better managed  |  17 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Inflation slowly rises due to higher tax rates and prices 5.  for imported food and energy Inflation picked up between January and July Monetary policy continues to be 2018, mostly tracking the prices of imported accommodative. In Albania and Serbia, which food and energy. Contributing factors were have floating exchange rates and inflation tax-related price hikes and the build-up in targeting, and FYR Macedonia, which has a de domestic demand (Figure 5.1). Yet core inflation facto pegged exchange rate, the central banks is relatively stable, which suggests that long- cut interest rates and intervened in the markets term inflationary pressures are being contained to smooth excessive short-term fluctuations (Figure 5.2). Inflation in Montenegro was the in the exchange rate and to ease the impact of highest in the region, driven by a higher VAT appreciation on domestic prices (Figure 5.3). rate and excises. In Bosnia and Herzegovina In Serbia, after two cuts in 2017 the key policy and in FYR Macedonia higher global energy rate was again lowered in March and April to prices and higher excise duties pushed up 3 percent. Similarly, in Albania, lower than prices for fuel and imported food. In Serbia and expected inflation associated with exchange rate Albania, appreciation of the national currencies appreciation triggered a cut in the policy rate and subdued food prices in the first quarter by 25 basis points (bps) to a new minimum of of the year helped ease inflationary pressures. 1 percent. In FYR Macedonia, reflecting prices Driving inflation in Kosovo was the rise in food still stagnant given the negative output gap and transport prices, although housing, energy, and the improved external position, the central clothing, and communications prices declined. bank in two steps lowered the key interest rate by 25 bps. In Bosnia and Herzegovina, Figure 5.1. Inflation, though slowly building, Figure 5.2. Food and energy prices have been is still contained. mainly driving inflation in the first half of 2018. Headline CPI inflation, y-o-y percent Inflation rate, y-o-y percent 4 3 3 2 2 1 1 0 0 -1 -1 -17 -17 r-1 7 -1 7 y-17 - 17 Jul- 17 -16 pr-16 Jul-16 ct-16 an-17 pr-17 Jul-17 ct-17 an-18 pr-18 Jul-18 Jan Feb Ma Apr Ma Jun Jan A O J A O J A ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ WB6 ▬▬ WB6 headline inflation ▬▬ EU28 headline inflation …… WB6 core inflation …… EU28 core inflation Source: Central banks and World Bank estimates. Note: Food and energy prices are included in headline but not core price indexes. Data for WB6 and EU28 calculated as weighted average. 18  |  5. Inflation slowly rises due to higher tax rates and prices for imported food and energy HIGHER BUT FRAGILE GROWTH the currency board also continues to support against the euro in Albania and Serbia (Figure monetary policy. 5.4). Although reflecting higher demand for these countries’ exports, currency appreciation Most exchange rates appreciated. Strong might not last, as emerging markets may be foreign currency inflows from exports, plus headed for a period of increased volatility (see several one-off factors, drove up appreciation Section 8). Figure 5.3. Monetary policy further eased in Figure 5.4. …as their currencies appreciated. the economies using inflation targeting… Official policy interest rates, percent Exchange rate changes June 2017 to June 2018, percent; increase indicates depreciation 5 5 4 0 3 2 -5 1 0 -10 -16 pr-16 Jul-16 ct-16 an-17 pr-17 Jul-17 ct-17 an-18 pr-18 Jul-18 Jan A O J A O J A USD EUR REER ▬▬ ALB ▬▬ MKD ▬▬ SRB ▬▬ Eurozone JJ SRB JJ ALB JJ BIH JJ MKD JJ KOS JJ MNE Source: National authorities and World Bank staff estimates. Note: Kosovo and Montenegro are unilateral euro adopters. 5. Inflation slowly rises due to higher tax rates and prices for imported food and energy  |  19 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Lending to households drives credit growth; despite lower 6.  NPLs, corporate lending is sluggish Credit outstanding2 continued to rise in loans and 3.2 percent for corporate loans most Western Balkan countries, reflecting (compared to 8.7 and 3.3 percent in December recent reforms. Kosovo continued to show the 2017). strongest growth of credit outstanding to the private sector at over 11 percent in July 2018 De-euroization strategies are pushing up (y-o-y), thanks to improving credit terms, lending in domestic currencies, which reduces reforms to firm up contract enforcement, currency risk for unhedged borrowers. The and less bank aversion to risk (Figure 6.1). In central banks in FYR Macedonia and Serbia Montenegro, accelerating growth in credit to continue to work to de-euroize banks’ balance the private sector exceeded 9 percent as asset sheets, keeping reserve requirements for foreign quality continued to improve and deposits, a exchange-linked deposits higher than for the major source of funding for local banks, grew local currency and in the case of Serbia also substantially. At 5 to 7 percent, lending also assigning higher risk weights to unhedged remained robust in Bosnia and Herzegovina, borrowers. After some efforts to reduce lending FYR Macedonia, and Serbia. Headline credit in foreign currencies, in January 2018 the outstanding fell in Albania, partly reflecting Bank of Albania launched a comprehensive the recent exchange rate appreciation, which strategy to reduce the use of foreign currency. reduced the value of loans denominated in Progress in de-euroization has been gradual; foreign currency. Despite general progress in outstanding loans in foreign currencies still credit market deepening across the Western range from below 45 percent of total loans in Balkans, domestic credit to the private sector FYR Macedonia to over 60 percent in Serbia continues to significantly lag behind levels in and 50 percent in Albania. the European Union. Although NPLs are still high in most Lending to households continues to drive countries, improving asset quality is helping credit growth, mirroring the importance in drive credit growth. NPLs burden bank balance the region of private consumption in driving sheets, undermine profits, and erode capital . GDP growth. Lending to corporations is more High NPLs make it harder for banks to use the uneven, with write-offs of NPLs still suppressing credit channel to support economic growth. credit growth (Figure 6.2). The regional average Kosovo has the lowest NPLs in the region. for growth in credit outstanding between July Although NPLs are heading down in other 2017 and 2018 was 9.1 percent for household countries, they are still high (Figure 6.3). FYR Macedonia and Kosovo had less exposure to international markets before the crisis and thus 2 Credit here refers to the stock of nonfinancial private sector credit outstanding. Its growth reflects changes in both new credit less need for reforms, likely a reason their NPLs (positive effect) and NPL write-offs (negative). So far this year, due to large write-offs in several countries (for which the data are not are below pre-crisis levels. Albania, Montenegro, always current), the dynamic of credit outstanding does not match and Serbia continue to write off and sell old new credit growth. This effect is likely to ease by yearend as write- offs slow. NPLs, and have reduced NPLs considerably 20  |  6. Lending to households drives credit growth; despite lower NPLs, corporate lending is sluggish HIGHER BUT FRAGILE GROWTH Figure 6.1. Credit outstanding continued to Figure 6.2. Credit to households grew; credit increase in most countries. to firms dwindled. Change in nonfinancial private sector credit outstanding, percent Change in credit outstanding, percent y-o-y in July 2018 y-o-y 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -16 -17 -17 -17 -18 -18 Dec Apr Aug Dec Apr May ALB BIH KOS MKD MNE SRB ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ WB6 JJ Firms JJ Households Source: IMF IFS, central banks. Note: Consistent data on private sector credit growth in Albania, Bosnia and Herzegovina, Macedonia FYR, and Serbia are from the IMF International Financial Statistics (IFS), which is currently available through May 2018. Data on household and corporate credit are from national central banks. Other depository corporations surveyed are expressed in local currency (except in euros for Kosovo). Data for Montenegro are based on central bank statistics for credit to residents but not to governments and financial institutions. Figure 6.3. Nonperforming loans are declining. Figure 6.4. Banks are adequately capitalized. NPLs as percent of total loans Percent and percentage points 30 25 25 20 20 15 15 10 10 5 5 0 0 ALB BIH SRB MNE MKD KOS SRB KOS ALB MKD MNE BIH JJ Mar-17 JJ Mar-18 QQ Peak since 2008 JJ Mar-17 JJ Mar-18 QQ Average (2006–08) ‹‹ Pre-crisis level (end 2007) Source: IMF FSIs, National central banks. Source: IMF FSIs, National central banks. since 2017, especially Serbia. New insolvency NPLs and revise its capital requirements in laws are in place in Albania and the Bosnia and compliance with the EU Capital Requirements Herzegovina entity Republika Srpska. Albania Directive. As of March 2018, the regional NPL is preparing to introduce a system for voluntary average was 8 percent of total loans. While out-of-court restructuring. Montenegro has NPLs in Albania have steadily declined from expanded coverage of the credit registry to over 20 percent at peak to 13.3 percent as of enhance the capacity of lenders to assess credit June, that is still the highest in the region; at risk and is working to redefine and reclassify 2.8 percent, Kosovo has the lowest NPLs. 6. Lending to households drives credit growth; despite lower NPLs, corporate lending is sluggish  |  21 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Banks in the Western Balkans remain of these firms consider access to finance their well-capitalized, though further bank biggest obstacle in doing business, compared to consolidation is still expected. As of March, just 7 percent of large enterprises.3 For smaller bank capital adequacy averaged 17.6 percent businesses, identifying alternative sources of (Figure 6.4). Profitability, though low, is on funding could help drive innovation and long- the rise, with a regional average return on assets term growth. of 1.8 percent as of March 2018. However, domestic bank vulnerabilities continue to raise concerns about asset quality and the health of specific banks. In Serbia, despite improvements in the banking system as a whole, the quality of state-owned bank assets is a source of risk. Structural changes in the banking sector continue with the planned sale of some foreign-owned subsidiaries as parent banks realign country exposures and smaller domestic institutions merge in Albania, Bosnia and Herzegovina, FYR Macedonia, and Serbia. Considering the size of Western Balkan economies and their financial sectors, there is room for further consolidation, the entrance of reputable players, and banking efficiency gains. Diversifying financial systems is important to open up access to financing and the availability of term financing to foster investments—and ultimately economic growth. Financial systems in the Western Balkans are dominated by banks, which hold on average 85 percent of assets; there is very little capital market activity (stock market cap-to-GDP ratios average 19 percent and government securities-to-GDP 29 percent); penetration of insurance products is negligible; and nonbank financial institutions are generally insignificant. Bank liquidity, while ample, tends to be short-term, limiting the financing available for firms to invest and grow. Access to finance thus continues to be a challenge for firms in the region, especially micro, small, and medium enterprises. About 15 percent 3 Based on World Bank Enterprise Survey data. 22  |  6. Lending to households drives credit growth; despite lower NPLs, corporate lending is sluggish HIGHER BUT FRAGILE GROWTH In most countries, despite export growth external deficits 7.  are still high External deficits are expected to remain Herzegovina, the current account deficit is stable but elevated in most countries  (Figure expected to go up moderately, from 4.8 percent 7.1). In Montenegro the current account deficit of GDP in 2017 to 5.3 percent because of a (CAD) is expected to amount to 16.4 percent rising goods trade deficit. Kosovo’s is projected of GDP—about the same as in 2017 but by far to reach 6.9 percent of GDP; its deficit in trade the largest in the region. The elevated external of goods is rising because of higher imports imbalance is a potential threat to Montenegro’s of intermediate goods used for investment external sustainability given its dependence on and lower exports because production of the FDI and foreign financing, but it also reflects Ferronikeli plant has halted. high investment-related imports during the construction of the Bar-Boljare highway. Albania Goods and services exports continued and FYR Macedonia have both improved their to grow, but so did imports ( Figure 7.2). trade deficits and are expected to have slightly Higher demand from the EU—the region’s lower CADs, 6.8 percent of GDP for Albania main trading partner—and higher prices for and 1.2 percent for FYR Macedonia. Serbia’s commodities resulted in higher exports for CAD is expected to hold at the 2017 level, most Western Balkan countries. However, 5.7 percent of GDP, because rising imports because the exports of those countries depend of equipment and intermediate goods were heavily on imports of intermediate goods, as neutralized by a surplus in trade in services do infrastructure construction, consumption, and higher net transfers. In Bosnia and and energy supply, imports also increased Figure 7.1. External deficits in the region have Figure 7.2. Trade in goods drove the change held steady. in CADs, helped in some countries by new services exports. Current account balance, percent of GDP Contribution to changes in current account deficit, 2018e, percent of GDP 0 4 é Reduced exports, increased imports -2 -4 2 -6 -8 -10 0 -12 -14 -2 -16 -18 -20 -4 ê Increased exports, reduced imports 2012 2013 2014 2015 2016 2017e 2018e BIH KOS MNE SRB MKD ALB ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ WB6 JJ Goods exports JJ Goods imports JJ Net services exports JJ Remittances JJ Others QQ Change in CA deficit Source: Data from central banks and national statistical offices; World Bank Source: Data from central banks and national statistical offices; World Bank estimates. estimates. Note: Data for WB6 calculated as weighted average. Note: “Others” mainly refers to repatriation of profits. 7. In most countries, despite export growth external deficits are still high  |  23 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 substantially, attenuating the gains in the to sudden stops in capital inflows or increasing trade balance. Albania is projected to have costs of external financing. Especially for small the largest improvement in the goods trade countries, high stable growth is impossible balance in 2018, 2.2 percent of GDP, as a without deeper trade integration; it boosts result of higher energy exports. However, its the size of accessible markets for successful positive services trade balance is projected to domestic firms and makes countries exploit decline significantly, resulting in only marginal comparative advantages and economies of improvement in the goods and services trade scale. Regional integration is a stepping stone balance of 0.3 percent of GDP. The pattern is to global integration and global value chain similar in Montenegro: in June exports of both participation (see also the Spotlight on regional goods and services had surged by 21.4 percent integration at the end of this report). y-o-y, led by steel, aluminum, mineral fuels, wood, and tourism, but they were partially Stable FDI and remittances helped finance offset by rising imports of cars, furniture, external imbalances ( Figure 7.3 and Figure electric machinery and equipment, iron, and 7.4). Total FDI in the region is expected steel. On the other hand, goods trade balances to reach 5 percent of GDP, slightly lower are expected to deteriorate by 3.4 percent in than in 2017 because it declined in all Kosovo, due to a disruption in the production countries except Bosnia and Herzegovina and of the Ferronikeli plant, and by 0.9 pp in Bosnia FYR Macedonia. The inflow of remittances and Herzegovina as import growth surpassed in the Western Balkans is comparable to that export growth. In both countries, the trade of FDI, estimated at between 1.9 percent of deficit in goods was partly compensated for by a GDP in FYR Macedonia and 11.9 percent in surge in services exports, particularly in Kosovo Kosovo. Despite new fiscal measures to attract due to higher tourist income (largely diaspora FDI in 2018, Kosovo saw the biggest decline travelers) and in Bosnia and Herzegovina to in FDI, from 4.0 to 1.9 percent of GDP increases in transport and tourism services. In between 2017 and 2018, though it was partly FYR Macedonia and in Serbia, the goods and covered by strong growth in remittances. As services trade balances improved because of in previous years, Montenegro is expected to solid exports, driven in Serbia by foreign firms have the highest inflow of FDI as a share of and ICT services and in FYR Macedonia due GDP, reaching 9.3 percent and covering about to higher exports in the auto parts industry. 60 percent of its CAD. Investments in Serbia Complementarity of the export baskets of the are expected to total 6.5 percent of GDP (at countries in the region should create incentives the same level as in 2017), also aided by robust for regional integration, which is a stepping 20.6 percent y-o-y growth in remittances that stone toward higher volumes of exports (Box were in total about 6.5 percent of annual GDP. 7.1). In Bosnia and Herzegovina both FDI and remittances are expected to continue to grow Despite high export growth, the share of steadily; FDI growth of about 2.1 percent exports in GDP remains low. Low exports of GDP and remittance inflows of about represent a missed opportunity to speed up 8.2 percent are helping to balance the external growth and improve external balances. High account. In FYR Macedonia, a rebound in external imbalances make countries vulnerable FDI—to an estimated 3 percent—is driven by 24  |  7. In most countries, despite export growth external deficits are still high HIGHER BUT FRAGILE GROWTH investments in services, primarily finance and only high but increasing. Still, in 2018 the insurance, and manufacturing, primarily motor ratio of external debt to GDP is projected to vehicles. remain elevated for the Western Balkans at 80.5 percent of GDP. Currently, FDI finances The slight rise in external debt in 2018, a considerable part of the CADs. A sudden in most countries from an already high stop in foreign investments or an increasing base, implies that some countries continue reliance on imports, especially for consumption to depend on external financing. Even goods, would amplify dependence on external though Western Balkan countries had been financing and may jeopardize foreign currency registering growing exports and FDI, which reserves (see Section 8). In 2018, however, are improving their trade balance and external all Western Balkan countries are projected positions, in most there are risks associated to maintain reserves exceeding 4 months of with the persistence of high CADs, especially imports. when external debt-to-GDP ratios are not Figure 7.3. Stable FDI helped finance most Figure 7.4. …but overall, FDI inflows CADs… stagnated at low levels. Four-quarter rolling sum, € millions Net FDI to GDP, percent 6,000 12 6 5,000 10 5 8 4 4,000 6 3 3,000 4 2 2,000 2 1 1,000 0 0 0 -2 -1 -1,000 -4 -2 -2,000 -6 -3 3 -13 -14 -14 -15 -15 -16 -16 -17 -17 -18 r-1 r r r r r Ma Sep Ma Sep Ma Sep Ma Sep Ma Sep Ma MNE ALB SRB MKD KOS BIH WB6 ▬▬ FDI inflows ▬▬ Portfolio investment inflows JJ Net FDI to GDP 2018e QQ 2017–18e change in net FDI to GDP, pps, rhs ▬▬ Other investment inflows Source: Data from central banks and national statistical offices; World Bank estimates. Note: Dynamics of net FDI inflows in the Western Balkans closely track that of FDI. Box. 7.1. Potential for value chain integration for Western Balkan exports to the EU. The main market for all Western Balkan exports is the EU ( Figure B7.1.1). But the products exported to the EU are far from uniform, despite the historical ties of the region to the former Yugoslavia. Instead, there are substantial differences in export specializations. For Bosnia and Herzegovina, miscellaneous manufactured articles like apparel and footwear and manufactured goods like aluminum struts dominate its exports to the EU. FYR Macedonia and Serbia both specialize in exporting to the EU machinery and transport goods, such as auto parts. But Serbia has also specialized in exporting food products and FYR Macedonia chemical products to the EU. Exports 7. In most countries, despite export growth external deficits are still high  |  25 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Box 7.1 continued from Montenegro and Albania are dominated by services, especially tourism, and their goods exports are dominated by other manufactured products. The different specialization patterns for exports to the EU are even more apparent when the categories are broken down into detail. The only top-three export products (SITC 4-digit level) to the EU that are exported by more than one country are footwear (Albania and Bosnia and Herzegovina), electric current (Bosnia and Herzegovina and Montenegro), and insulated electrical wiring (FYR Macedonia and Serbia). While footwear companies from Albania and Bosnia and Herzegovina compete in the EU market, most of the major export products of other Western Balkan countries do not necessarily compete for EU market shares. Figure B7.1.1. Western Balkans Export Composition and Destinations. 26  |  7. In most countries, despite export growth external deficits are still high HIGHER BUT FRAGILE GROWTH Box 7.1 continued The export specialization patterns suggest opportunities for cooperation through efficiency- enhancing activities like value chain integration. For example, Serbia exports cars to Italy mostly from the massive Fiat Chrysler plant while suppliers in FYR Macedonia specialized in exporting insulated electrical wiring, which is very important in automobile production and may thus open up opportunities for mutual trade. Unlike export products, which offer opportunities for countries with similar specializations to compete, in some services sectors exports are by nature complementary. Because popular tourist destinations in the Western Balkans are not far apart, for instance, countries like Albania and Montenegro may be able to benefit more from the vitality of each other’s tourism by bundling travel packages between famous sights in both (Table B7.1.1). Moreover, tourism sectors in both countries offer opportunities for local sourcing of necessary services or goods, such as food, reinforcing trade links between Western Balkan countries. Similarly, ICT firms in Belgrade can benefit from working with programmers or web designers based in Sarajevo, Skopje, or other cities in the region. Table B7.1.1. Composition of Western Balkan services exports. Share of Each Service Category to GDP, percent Country ICT Transport Tourism Total Albania 6 2 13 20 Bosnia and Herzegovina 3 2 4 9 FYR Macedonia 8 3 2 14 Montenegro 4 5 20 29 Serbia 7 3 3 12 Although most Western Balkan countries were formerly parts of a single country, their baskets of exports to the EU are quite different. They are therefore not necessarily competing directly with each other for the same EU markets or for FDI from the same EU firms. Rather, the differences in product specialization offer opportunities for more regional integration, including integration into value chains in such sectors as food, automobiles, or tourism. Given the different strengths and weaknesses of each country, there is room for mutual gains from economic cooperation throughout the Western Balkans. Source: WB staff calculations the Observatory of Economic Complexity data, MIT. 7. In most countries, despite export growth external deficits are still high  |  27 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 8.  The growth outlook is positive, but fragile Medium-term growth in the Western Balkans A possible surge in external and domestic is projected to solidify its upward trend, risks clouds the positive growth outlook. On reaching 3.5 percent in 2019 and 3.8 percent the external front, the main risk is tightened in 2020 ( Table 8.1). In FYR Macedonia, financing conditions for emerging markets investment is expected to continue to recover related to normalization of monetary policy in because of the improving political climate, Europe, crises in a number of leading emerging higher external demand, and investments in markets, and uncertainty related to global transport infrastructure. Growth in Serbia protectionism. In addition, political stability is expected to pick up to 4 percent by 2020, in the region, current debates in the EU, and supported by higher exports and investment. questions about the robustness of economic Kosovo is projected to grow by 4.5 percent in growth in the EU not only raise concerns but 2019–20, the highest growth in the region, as also elevate domestic uncertainties within the consumption recovers and two large transport region. These stem primarily from the potential infrastructure projects are launched. Supported for delay or derailment of structural or fiscal by domestic demand, growth in Bosnia and consolidation reforms caused by the elections Herzegovina is expected to accelerate, reaching on the horizon in several countries and other 3.9 percent by 2020. In contrast, growth in political events. Other factors, such as any Albania and Montenegro is projected to taper unmitigated risks of natural disasters (especially off slightly: Economic activity in Montenegro floods and droughts, see RER#13 for a full is slacking off as fiscal consolidation advances discussion) and political risks, also heighten the and investment in public transport declines. general uncertainty. In Albania it is projected to slow somewhat as private investment decelerates after two large A potential tightening of the financing FDI-financed energy projects are completed. conditions in international capital markets is a downside risk, especially in countries with Table 8.1. With growth likely to recover, external or fiscal imbalances. As reported the outlook is positive. above, PPG debt increased sharply after the Percent global financial crisis and remains high in 2017 2018e 2019f 2020f several Western Balkan countries (see Figure Albania 3.8 4.0 3.6 3.5 4.5). Although external deficits have generally Bosnia and Herzegovina 3.0 3.2 3.4 3.9 improved since before the global financial Kosovo 3.7 4.0 4.5 4.5 crisis, only Serbia and Albania have lowered Macedonia, FYR 0.0 2.5 2.9 3.2 both external and fiscal imbalances. While Montenegro 4.3 3.8 2.8 2.5 external deficits have often declined somewhat, Serbia 1.9 3.5 3.5 4.0 in 2018 fiscal vulnerability has increased WB6 2.4 3.5 3.5 3.8 compared to 2007 (Figure 8.1). Elevated twin Source: Central banks and national statistics offices; World Bank estimates deficits, external and fiscal, presage coming and projections. refinancing needs. With domestic sovereign 28  |  8. The growth outlook is positive, but fragile HIGHER BUT FRAGILE GROWTH bond markets often underdeveloped, Western Figure 8.1. The combination of external and Balkan countries are heavily exposed to global fiscal deficits heightens regional vulnerability to rising costs for financing. interest rate increases. The tightening of external Current account balance, financing conditions—from a contagion of percent of GDP, 2007 and 2018e 10 emerging markets due to events in Turkey or EU 18e 5 EMG 07 Argentina or from normalization of monetary 0 EMG 18e EU 07 BIH 18e SRB 18e policy in the developed world—could trigger -5 MKD 18e KOS 18e MKD 07 KOS 07 WB6 18e BIH 07 the need for major fiscal consolidations, which -10 ALB 07 ALB 18e -15 WB6 07 could have severe adverse impacts on economic -20 MNE 18e SRB 07 activity (Box 8.1). The effects of possible -25 contagion from emerging markets to Western -30 -35 Balkan countries could be small, given minimal MNE 07 -40 financial sector links and high share of FDI -45 investment, but deterioration in the cost or -6 -4 -2 0 2 4 6 8 Fiscal balance, percent of GDP, 2007 and 2018e availability of external financing is a worrying Source: National statistical offices, World Bank staff calculations, IMF risk that could be exacerbated by exchange rate World Economic Outlook. Note: EMG refers to the IMF’s Emerging and Developing economies movements, such as the appreciation of the classification of countries. U.S. dollar. Box. 8.1. Impact of the situation in Turkey on the Western Balkans. Turkey has been experiencing intense market volatility and economic stress. The value of the Turkish lira reached an all-time low in August 2018, having lost 87.5 percent of its value against the U.S. dollar since the beginning of the year. This situation was caused by a combination of overheating in the economy, changes in economic institutions, and a tightening in the external finances. Turkey is coping with problems related to the high current account deficit (CAD) and other external economic relations and its external financing needs, which are nearly 30 percent of GDP. Moreover, inflation has been persistently high—in August 2018 it was 17.9 percent, year-on-year. Turkey is a key economic partner of the Western Balkans:  (1) It is an important trading partner: Turkey accounts for between 1 percent (Albania) and 6 percent (Montenegro) of exports. The Western Balkans mainly export metals, oil seeds, and cereals to Turkey. Textiles, apparel, and electronics dominate imports from Turkey, which account for between 3 percent (Montenegro) and 10 percent (Kosovo) of the total imports. (2) Turkish banks are present in all six Western Balkan countries. Although they hold 0.1 percent of the market share in Serbia and 1.3 percent in Montenegro, they hold 22 percent of total banking sector assets in Kosovo and 28 percent in Albania. (3) Turkish investment is of particular importance in Kosovo (10.2 percent of total FDI) and in Albania and FYR Macedonia (about 5 percent). The risk of contagion is manageable, with the main channel of potential impact through capital flows into emerging markets. The risk of contagion through the banking system is small. Should there be a risk through Turkish private sector borrowing from European banks, the banks are well- capitalized, with access to funds still easy. However, like other emerging markets, Western Balkans 8. The growth outlook is positive, but fragile  |  29 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Box 8.1 continued countries are vulnerable to contagion from the capital markets. Although the high presence of Turkish banks in Albania and Kosovo is an additional risk, these operate as separate legal entities and are subject to national monitoring and safeguards. The main risk is the contagion through investor aversion to emerging markets, which may prompt them to sell riskier assets as investors search for yield in the low interest rate environment. Table B8.1.1. Channels for transmission of Turkish market volatility to Western Balkan countries. Export of Import of G&S FDI inflow Banking Banking sector Banking G&S (Exports (Import from (Turkey’s sector (Share of sector to Turkey as Turkey as share of (number of Turkish banks (credit in percent of the percent of the the total) Turkish in total assets) Turkish Lira) total export) total import) banks) Albania 0.8 7.5 5.0 1 27.9 n.a. Bosnia and 3.9 4.2 3.1 1 3.5 0 Herzegovina Kosovo 1.9 9.6 10.2 3 22.0 n.a. Macedonia, FYR 1.6 4.8 5.3 1 9.2 0 Montenegro 6.0 3.1 3.6 1 1.3 0 Serbia 1.8 3.7 0.7 1 0.1 0 Note: 2017 data, except for FDI for FYR Macedonia and Bosnia and Herzegovina where the stock data is used. Source: World Bank staff calculations. Notes: 2017 data, except for FDI for FYR Macedonia and Bosnia and Herzegovina where the stock data is used. Uncertainty related to a possible escalation for targeted goods previously imported from of trade disputes could delay or deter the U.S. or China. But further tariff surcharges, investment. The risks of disruption to trade currently under official study, pose significant flows are added to those of trade negotiations risks, especially when they are expanded to on NAFTA and between the EU and the UK. include the car industry. That is, even with As uncertainty rises, investors become more uncertainty of repercussions through the value cautious, especially about entering industries chains, new U.S. tariffs on cars from the EU are like automobile production. New U.S. tariff likely to have significant adverse effects on FDI hikes may worsen uncertainty and market inflows and exports of the Macedonian and volatility. So far, import costs are limited to Serbian car and car parts industries—which are U.S. tariffs on steel and aluminum, U.S. tariffs significant to the economies of both countries. on certain goods from China, and, in response, An escalation of the trade conflicts might trigger tariffs by Canada, China, the European Union, a general global decline in investor confidence India, Mexico, and Turkey on a variety of that would have major repercussions for all U.S. goods (Box 8.2). As long as current tariff Western Balkan economies. actions are targeted against a single country, there may be an opportunity for exports of Stronger economic growth in the EU has Western Balkan countries to partially substitute major upside potential. Favorable external 30  |  8. The growth outlook is positive, but fragile HIGHER BUT FRAGILE GROWTH demand from the EU would support export the relationship between Serbia and Kosovo, growth and the inflow of remittances into and FYR Macedonia’s agreement with Greece Western Balkan countries. Although global on its name. On the domestic front, risks are growth has eased slightly, it remains robust primarily related to upcoming elections in enough to reach a projected 3.1 percent in several countries and the resulting slowdown in 2018 and 2.9 percent in 2020.4 While growth carrying out structural reform programs. is expected to decelerate in other advanced economies, it is expected to accelerate somewhat Mitigating these risks requires both staying in the Euro Area relative to 2017. Robust committed to fiscal consolidation, and external demand is expected to drive goods giving impetus to structural reforms. In exports in FYR Macedonia and Serbia and the short term, launching credible medium- services exports in Albania and Montenegro. term fiscal consolidation strategies is thus Moreover, stronger private investment financed necessary to reduce deficits to create fiscal by FDI in Kosovo, FYR Macedonia, and Serbia space to finance higher-quality public services is tied to robust growth projections in the EU. and build buffers against adverse economic shocks. These strategies need to be based on Robust growth in the region depends on making public spending more efficient so that domestic and regional political stability. better public services can be delivered more Political stability strengthens both investor effectively. But they also need to emphasize confidence and private consumption; strengthening public financial management investment uncertainty heightened by political and making public finances more transparent instability is a major downside risk to the and accountable. To sustain higher growth, the positive growth outlook in the region. In the growth strategies of Western Balkan countries EU, as the European Central Bank starts to must move away from reliance on unsustainable moderate its quantitative easing program, transfers to individual groups or firms and some countries struggle with high borrowing toward structural reforms that generate formal costs and high debt, and growth projections private sector jobs by boosting human capital, vary widely depending on assumptions about firm productivity, and innovation. This requires the potential impact of tightening, or a leveling the playing field for firms by removing more disorderly interest rate adjustment, on regulatory barriers to firm entry, reinforcing some vulnerable EU economies. Industrial the mandate—and the power—of competition production declined in the EU in the first half authorities, making state aid programs more of the year. Combined with other political transparent, ensuring that public procurement events, these internal challenges may distract is transparent and competitive, removing attention from EU enlargement and reduce the barriers to trade and FDI in services sectors, pressure for structural reforms in the Western enhancing the independence and efficiency Balkans. Political tensions in the Western of commercial courts, and reducing the costs Balkans may also have an impact, including related to hiring formal employees. And it also requires boosting the quality of public services, including education more responsive to market 4 World Bank, 2018, “Global Economic Prospects, June 2018: needs, reforming pension, social assistance, and The Turning of the Tide?” Washington, DC: World Bank. doi: 10.1596/978-1-4648-1257-6. health care systems to overcome their structural 8. The growth outlook is positive, but fragile  |  31 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 and demographic challenges. The success of these reforms, beyond mere adoption of general laws, is critical to both mitigate external and domestic risks and to enhance Western Balkan growth potential and thus incomes region- wide. Box 8.2. Impact of global trade tensions on the Western Balkans.  e current round of trade disputes, involving the United States, China, and U.S. trading partners, Th may create both opportunities and risks for the Western Balkans. What has happened: I  n 2018, in unusual circumstances several countries introduced import tariff surcharges on a variety of goods. These included U.S. tariffs on steel and aluminum from almost all countries (March 2018), U.S. tariffs on certain goods from China valued at about $50 billion, Chinese tariffs on certain goods from the U.S. valued at about $50 billion (July/August 2018), and tariffs by Canada, China, the European Union (EU), India, Mexico, and Turkey on a variety of U.S. goods, in response to the U.S. tariffs on steel and aluminum (April–July 2018). Officials are studying further tariffs, among them U.S. tariffs on another $200 billion of imports from China, Chinese tariffs on another $60 billion of imports from the U.S., and U.S. global tariffs on imports of autos, auto parts, and uranium. The recent U.S. actions and the counter-actions of U.S. trading partners are now subjects of disputes at the World Trade Organization. Channels of influence:  Tariff surcharges on U.S. imports of particular categories of goods, to the extent that they are global or near-global, could reduce U.S. imports from the Western Balkans to the extent that Western Balkan countries actually export any of these goods to the U.S. At present, this applies to the steel and aluminum tariffs. Additional U.S. tariffs on consumer goods could further disrupt global value chains by reducing demand for upstream goods or services supplied to targeted industries. The U.S., for example, is currently considering imposition of import tariffs on autos worldwide. This would most likely reduce the volume of US imports of cars from the main European producers and thus, in turn, reduce their demand for auto part imports, which would attenuate exports—and possibly FDI into the Western Balkan auto parts industry.  e current tariff actions, however, are targeted against specific countries. In these cases, there might Th also be an opportunity for Western Balkan exports to increase because they might partially substitute for targeted goods previously imported from the U.S. or China. Model-based estimates indicate that tariff surcharges imposed due to the U.S.-China trade dispute would have a small positive impact on exports of most other regions of the world but a negligible impact on their GDP. However, if escalation of trade conflicts and accompanying uncertainty leads to a significant global decline in investor confidence, all regions of the world would be harmed. Potential impact on the Western Balkans:Figure B.8.2.1 shows the value of Western Balkans exports that appear on product lists in current trade disputes. At the moment, goods exposed to the potential for export expansion substantially outweigh in value goods facing new tariff barriers. U.S. imports of targeted steel and aluminum from the Western Balkans amount only to about $21 million a year. However, imports of specific goods on targeted product lists are much larger, amounting to 32  |  8. The growth outlook is positive, but fragile HIGHER BUT FRAGILE GROWTH Box 8.2 continued about $1.2 billion for EU imports of targeted U.S. goods, $296 million of U.S. imports of targeted China goods, $77 million of China’s imports of targeted U.S. goods, $21 million of Turkey’s imports of targeted U.S. goods, and $5 million of Canada’s imports of targeted U.S. goods. Figure B8.2.1. Imports of Western Balkan goods affected by recent trade actions 2015–2017 averages, US$ million 1.2 1.0 0.8 0.6 0.4 0.2 0 of ts o f ts o f of of ts o f orts ds por ods porgoods orts ds orts ds por um imp goo . imina go a im impS. goo impS. goo . im lumin EU U.S. . S i n . S. e y . d a . . S d U Ch Ch ted U Turk dU a U Cangeted U nd a gete ted targ e targ ete la tar targe tar stee JJ ALB JJ BIH JJ MKD JJ MNE JJ SRB Source: World Bank staff calculations using UN Comtrade dataset. See also Freund, Caroline, Michael Ferrantino, Maryla Maliszewska, and Michele Ruta, July 2018, “Impacts on Global Trade and Income of Current Trade Disputes,” Macroeconomics, Trade and Investment MTI Practice Notes No. 2, World Bank Group. Washington, DC. Potential impact on specific Western Balkan exports: The U.S. imports primarily certain hot-rolled steel products from Serbia and FYR Macedonia. These exports to the U.S. will likely decline. They amount to 4.5 percent of current Serbian exports to the U.S. and 2.8 percent of current Macedonian. EU imports from the Western Balkans of goods targeted from the U.S. are dominated by iron, steel and, aluminum products, apparel, furniture, and cereals. The share of all EU imports from the Western Balkans that appear on the targeted list is significant, ranging from 4.1 percent for FYR Macedonia to 10.7 percent for Albania. U.S. imports from the Western Balkans of goods targeted from China, on the other hand, are dominated by motor vehicles, electric motors, circuit boards, and miscellaneous electrical and mechanical capital and intermediate goods. These originate primarily in Serbia and FYR Macedonia.  estern Balkan exports of auto parts to the main European countries that export cars and trucks to W the U.S. (Germany, Italy, Norway, Slovakia, Spain, Sweden, and the U.K.) averaged €243 million from 2015–17—the most important auto parts exports are ignition wiring sets (€114 million) and motor vehicle seats (€54 million). The share of these parts used in autos produced for the U.S. rather than other markets is unknown. Serbia’s exports of auto parts of €101 million is the highest in the region and accounts for 2.4 percent of total Serbian exports to these countries, followed by FYR Macedonia (€63 million, 2.7 percent), Bosnia-Herzegovina (€62 million, 4.1 percent), and Montenegro (€3 million, 5.7 percent). 8. The growth outlook is positive, but fragile  |  33 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14  reater regional economic integration means 9.  Spotlight: G higher growth and more jobs Few small countries in Europe and Central with populations similar to or smaller than Asia have achieved high levels of income Western Balkan economies. In part, this reflects per capita without deep integration into legacy factors in the Western Balkans—such as the global economy. Economic integration a relatively limited productive base that now can facilitate access to a larger consumer base, needs to be gradually nurtured and a recent a greater pool of qualified workers, additional history of regional ethnic tensions that has sources of financing, and new technologies. A limited both intra- and inter-regional trade. larger market with an even playing field for However, in part this situation also calls for both domestic and international firms can further policy action. strengthen competition, shake up sclerotic industries, and encourage innovation. This is In 2017, recognizing the growth particularly important for small economies opportunities that can come with economic in Europe and Central Asia, where domestic integration, the Western Balkans initiated markets alone are not large enough to justify a joint Multi-Annual Action Plan (MAP) development of complex value chains and to develop a Regional Economic Area. where local closely connected political and This initiative promotes regional economic business elites can sometimes prevent the integration among the Western Balkan emergence of domestic competition.5,6 countries, but also aligns regional legal frameworks and infrastructure with the While the Western Balkans have made major requirements for eventual EU accession, to progress toward opening their economies, help full integration into the EU value chains. they continue to trail regional peers. For The MAP covers four dimensions of economic instance, while the average ratio of goods and integration: trade, investment, mobility, and services exports to GDP in the Western Balkans digital integration. Much has already been rose from about 30 percent in 2010 to about achieved: For instance, the Central European 40 percent in 2017, that is still behind levels Free Trade Association (CEFTA) Additional achieved by regional peers like Latvia (about Protocol 5 on trade facilitation has entered into 60 percent), Cyprus (about 65 percent). and force, a Regional Investment Reform Agenda Estonia (about 80 percent)—all of which have (RIRA) has been endorsed, and a Digital significantly higher income per capita even Reform Agenda has been launched. Building on this momentum, the region now 5 As population increases, the link between trade openness and high has a unique opportunity to move forward income per capita weakens. Nonetheless, even for an economy to greater regional and global economic of Serbia’s population, following the development path of open economies like Hungary, Belgium, and the Czech Republic is a integration. This requires decisive policy promising option. 6 Nonetheless, economic integration alone is unlikely to be sufficient actions on all dimensions of the MAP: to achieve high income per capita (see FYR Macedonia) and may not be the only pathway to high income in a small economy (see Norway). 34  |  9. Spotlight: Greater regional economic integration means higher growth and more jobs HIGHER BUT FRAGILE GROWTH yy Trade: Besides upgrading physical offer seamless access to a regional market. infrastructure and aligning tariffs, A regional investment plan will reduce nontariff obstacles to trade need to be obstacles to investor entry, better protect brought down. National single windows investors, streamline policies for attracting can streamline documentation processing investors, and, perhaps most important, for traders. Automating the cross-border better position the region for integrating process can alone save 2 percent in trade into global supply chains. Now is the time costs.7 Joint border crossings can reduce to translate RIRA into concrete actions to truck travel times. A risk-based approach align national investment frameworks. to border controls can slash the time inspection and other procedures take, and yy Mobility: To alleviate the brain drain thus the time to trade.8 There is also much and fill skills gaps, the Western Balkans export volume and product diversification need a more attractive value proposition to be gained through reliable standards for highly skilled workers. The region’s and certifications of quality that are skills gap is real. The 2018 Balkan harmonized with the EU. Business Barometer reports that in the last 12 months 1 in 5 businesses have had yy Investment: In 2017, across the region difficulties filling vacancies. Businesses average investment was 23 percent of identified lack of skills as the reason two- GDP, a third lower than the middle- thirds of vacancies went unfilled. The income-country average.9 Individual MAP foresees (1) making mobility simpler country initiatives to attract FDI have for researchers; (2) mutual recognition relied on blunt incentives like tax breaks of professional qualifications, such as and cash subsidies. Moreover, the type of those of doctors, dentists, architects, and FDI attracted has had limited spillover engineers, and (3) mutual recognition of to the rest of the economy. Obviously, academic qualifications. These initiatives this is not a sustainable strategy. RIRA can raise the value of acquiring and using offers a coordinated approach to regional skills; and together with national reforms investment. In a World Bank worldwide of education, they can help tackle the survey, close to 90 percent of investors said regional skills gap. that accessing new customers was a key motivation (World Bank Group 2018). yy Digital integration: The Western Balkans With RIRA, the Western Balkans can can seize the opportunities created by the digital revolution. Already, in Kosovo, the startup gjirafa is an inspiring example. 7 Evdokia. Moïsé, and Silvia Sorescu, 2013. “Trade Facilitation This company developed a search engine Indicators: The Potential Impact of Trade Facilitation on Developing Countries’ Trade,” OECD Trade Policy Papers 144, for the Albanian language. Using its OECD Publishing, Paris. success to raise capital in Silicon Valley, 8 In Montenegro, a risk-based approach to customs reduced inspections of imported excise goods by 80 percent and the average the business expanded by adding online release time for goods by 70%. http://www.worldbank.org/en/ news/feature/2018/06/11/a-new-way-of-managing-risk-for- content, such as digitizing bus schedules, customs-in-montenegro. video streaming services, and an online 9 Simple average of GFC ratios; World Development Indicators (WDI). market place that today serves Albania, 9. Spotlight: Greater regional economic integration means higher growth and more jobs  |  35 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Kosovo, and FYR Macedonia. The region and transportation, among others, complement has also attracted some big players, each other. The internet and efficient transport such as Microsoft, which has sited one links, for example, are both necessary to boost of its five global development centers exports, in goods as well as services. And both in Serbia. This has greatly stimulated are necessary for successful e-commerce to the startup scene there. With the right reap the benefits from the digital revolution. enabling environment, this is just the Moreover, technology transfers emerge from start for realizing the IT potential of the FDI linking domestic firms to global value Western Balkans. Doing so will include chains, creating local knowledge spillovers. And elimination of regional roaming charges, they are greater from countries that themselves a unified approach to digital security and have strong links to third countries. Therefore, a data protection, promotion of digital balanced approach to increasing all dimensions skills, and affordable and accessible high- of connectivity is desirable.10 speed broadband. The stakes are high, but economic integration This comprehensive approach to regional may be the key to the higher living standards integration is necessary to facilitate the the Western Balkans aspire to. Income per transfers of knowledge and technology that capita in the Western Balkans is still only are critical to sustained high economic growth 28 percent of Germany’s; at current growth and shared prosperity. Critical connections rates, it will take five decades for the region to between the Western Balkan countries through reach Germany’s current standard of living and trade, FDI, migration, telecommunications, Figure 9.1. Among small countries in Europe and Central Asia, high income per capita is closely correlated with trade openness. Exports of goods and services, percent of GDP 100 90 Hungary Belgium 80 Estonia Czech Republic 70 Bulgaria Belarus Cyprus 60 Latvia Macedonia, FYR Denmark Austria Georgia Croatia Serbia 50 Azerbaijan Iceland Sweden Montenegro Moldova Portugal 40 Armenia Bosnia and Norway Albania Herzegovina Greece 30 Kosovo 20 0 2 4 6 8 10 12 Population, millions QQ Income above USD 20 thousand ‹‹ Income below USD 20 thousand Source: World Development Indicators 2017; European and Central Asia (ECA) economies with population less than 12 million; excluding Luxemburg; income is measured as GDP per capita, PPP (constant 2011 international $). 10 See Gould, David Michael. 2018. Critical Connections: Promoting Economic Growth and Resilience in Europe and Central Asia. Europe and Central Asia Studies. Washington, DC: World Bank. 36  |  9. Spotlight: Greater regional economic integration means higher growth and more jobs HIGHER BUT FRAGILE GROWTH eight decades to catch up with Germany.11 New opportunities are needed to speed up growth— which means overcoming small and fragmented national markets. The process will be helped by the non-competing nature of countries’ exports (see Box 7.1). With a shared vision to ensure macroeconomic stability, carry bold reforms beyond borders, and enhance economic integration, the Western Balkans can accelerate growth, improve living standards, and reap the benefits of the new global economy. 11 The calculations are based on WDI GDP per capita (PPP constant 2011 international dollars). The Western Balkans ratio is a simple average of GDP per capita in Western Balkans countries. Projections are based on extrapolating the ratios forward, based on the five-year historical average growth rate of the ratios. 9. Spotlight: Greater regional economic integration means higher growth and more jobs  |  37 Country Notes HIGHER BUT FRAGILE GROWTH Albania yy Growth for 2018 is projected to be 4 percent, supported by a weather-related spike in hydroelectric power production and a strong tourism season. yy Employment growth is helping to reduce poverty. yy The primary fiscal deficit and public debt are expected to decline. yy In the medium term, growth is expected to gradually moderate to about 3.5 percent. Risks to this outlook include international situation in emerging markets, growth in the EU, and the success of the fiscal consolidation and tax reform. yy Fiscal consolidation, more efficient public spending, and structural reforms are still critical to sustainable and equitable growth. Main Developments and Trends in agriculture and construction should help boost the incomes of workers in the bottom Annual GDP growth for 2018 is projected 40 percent of the income distribution, at 4 percent. Hydroelectric power production heightening the prospects for less poverty for in the first half of 2018 nearly doubled from the year. the same period last year, driven by heavy rains. Tourism is boosting growth of services exports. In 2018 Albania’s fiscal deficit is forecast to Improving employment, wages, and credit hold at 2 percent of GDP. Fiscal revenues are growth continue to drive private consumption. expected to go up by 0.3 percent of GDP. Higher While private investment is decelerating social security contributions and national tax with completion of two large energy projects revenues compensate for lower than expected financed by foreign direct investment (FDI), VAT revenues and delays in introducing the heavy government spending on infrastructure new property tax. Similarly, spending is forecast is supporting growth in total investment. to increase by 0.3 percent of GDP, with capital Albania’s economic recovery in the first half spending going up by 22.5 percent, mainly of 2018 is expected to carry through into the for infrastructure, which will more than offset second half of the year. lower current transfers. The net fiscal balance is forecast to remain unchanged in 2018. In Sustained growth has supported job creation compliance with the fiscal rule, public debt is and encouraged participation in the labor expected to decline from 71.6 percent of GDP force. Employment grew by 4 percent in the in 2017 to 69.5 percent in 2018. Exchange rate first half, mostly in services and industry. The appreciation is expected to keep the external unemployment rate fell to 12.4 percent of the public debt share on GDP at a slightly lower labor force. Increased capacity utilization in level than last year, even though external certain segments of the labor market is building financing is expected to increase. up pressures on real wages, which grew by 2.3 percent in the first quarter, following a Following an appreciation of the exchange trend established in 2017. Real wage increases rate, the central bank intervened in the foreign Albania  |  41 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 exchange market and further eased monetary Given the strong performance of the labor policy. Strong foreign currency inflows from market since 2017, poverty is expected to exports and several one-off factors combined to decline faster in the next two years. Based on drive up the lek exchange rate in Spring 2018. the growth and consumption forecasts, poverty With inflation expected to average 2.1 percent is projected to fall by more than 2 pp a year, in 2018—below the 3 percent target—the reaching about 24 percent in 2020. However, central bank again lowered the policy rate the 9 percent minimum wage increase in 2017 by 0.25 percentage points (pp) to minimize could have an ambiguous effect on poverty, the impact of the appreciation on domestic reducing the number of jobs created at the prices. With the banking system liquid, well- margin while increasing the wages of those capitalized, and making progress in cleaning already working. up nonperforming loans, the monetary easing is expected to further stimulate credit growth. The fiscal deficit is expected to fall to 1.2 percent of GDP by 2020. Based on The current account deficit (CAD) is expected the medium-term fiscal framework, fiscal to reach 6.8 percent of GDP in 2018 as consolidation is expected to continue until exports in both goods and services expand 2022, which should generate savings on and outgrow imports. Stronger economic public wages, goods and services, and current performance in the EU is also supporting transfers to social insurance beneficiaries and remittances, which are expected to amount to local governments. At the same time, launch of 6.3 percent of GDP (in net terms). The CAD the new property tax in late 2018 will increase is fully covered by FDI. Meanwhile, foreign revenues. Sustained capital expenditures of exchange reserves have held steady, covering the 5 percent of GDP are planned over the medium equivalent of 6½ months of imports of goods term, and later this year additional investments, and services. financed through public private partnerships (PPPs), will be contracted. By 2022, gradual fiscal consolidation and continued economic Outlook growth are expected to lower the debt-to-GDP ratio to 60 percent. Albania’s economic growth is projected to slow to about 3.5 percent by 2019–20 as the Downside risks do threaten these positive increased economic dynamism gradually economic prospects. External risks include closes the output gap. Growth will rely a possible tightening of financing conditions increasingly on private consumption, fueled for emerging markets, and EU growth and by labor income gains, and on net exports, accession prospects which are also dependent supported by growing foreign demand and on current discussions in the Union. On the expanding market access. Investment—public domestic side, determined progress on fiscal and private—will also contribute to growth consolidation and broadening of the tax base are as the government continues to invest in necessary to preserve macro-fiscal stability as a infrastructure and the business environment foundation for growth. The government should improves. also actively manage fiscal risks from PPPs and 42  | Albania HIGHER BUT FRAGILE GROWTH state-owned enterprises and continue to make public spending more efficient. Sustaining inclusive growth requires a commitment to tackling structural challenges related to the business environment, energy security, and human capital. Albania  |  43 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Investment and consumption are expected to Government debt is declining as the fiscal drive growth in 2018. deficit narrows. Growth contributions, percent Percent of GDP 6 80 0 70 -1 4 60 -2 2 50 -3 40 0 30 -4 20 -5 -2 10 -6 -4 0 -7 0 1 2 3 4 5 6 7 8 9 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 201 201 201 201 201 201 201 201 201 201 202 JJ Consumption JJ Investment JJ Net exports ▬▬ Real GDP growth JJ Public debt ▬▬ Fiscal balance, rhs Source: INSTAT and World Bank. Source: Ministry of Finance and World Bank. Growth is supporting sustained recovery in the Inflation remained within the 3 ±1 percent labor market. target band, as monetary policy was again accommodative. Percent Percent 60 6 50 5 40 4 30 3 20 2 10 1 0 0 12 12 13 13 14 14 15 15 16 16 17 17 18 -10 an-11 an-12 an-13 an-14 an-15 an-16 -17 -18 Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Jan J J J J J J Jan Jan ▬▬ Employment ▬▬ Unemployment Source: INSTAT. Source: INSTAT Sustained non-debt-creating flows (FDIs) covered the current account deficit entirely. EUR million 300 200 100 0 -100 13 13 14 14 15 15 16 16 17 17 18 Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- ▬▬ FDI inflows ▬▬ Portfolio investment inflows ▬▬ Other invesmtnet inflows Source: Central Bank and World Bank. 44  | Albania HIGHER BUT FRAGILE GROWTH ALBANIA 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) 1.8 2.2 3.4 3.8 4.0 3.6 3.5 Composition (percentage points): Consumption 4.5 -0.9 0.1 2.1 1.5 1.9 2.1 Investment -0.9 0.7 1.4 2.3 1.5 1.2 1.2 Net exports -1.8 2.4 1.9 -0.5 1.0 0.5 0.2 Exports 0.9 0.5 6.5 5.7 4.4 4.4 4.2 Imports (-) 2.7 -1.9 4.6 6.2 3.5 3.9 4.0 Consumer price inflation (percent, period average) 1.6 1.9 1.3 2.0 2.1 2.5 2.9 Public revenues (percent of GDP) 26.3 26.6 27.6 27.7 28.0 28.2 28.3 Public expenditures (percent of GDP) 32.3 31.5 29.4 29.7 30.0 29.9 29.5 Of which: Wage bill (percent of GDP) 5.1 5.1 4.6 4.7 4.7 4.7 4.6 Social benefits (percent of GDP) 9.9 9.9 10.3 10.2 10.2 10.2 10.1 Capital expenditures (percent of GDP) 4.3 4.4 4.0 4.4 5.1 5.0 5.0 Fiscal balance (percent of GDP) -6.0 -4.9 -1.8 -2.0 -2.0 -1.7 -1.2 Primary fiscal balance (percent of GDP) -3.1 -2.2 0.5 0.1 0.3 0.7 1.2 Public debt (percent of GDP) 66.1 69.1 68.7 67.8 65.5 62.7 61.7 Public and publicly guaranteed debt 72.0 72.7 72.3 71.6 69.5 67.2 64.8 (percent of GDP) Of which: External (percent of GDP) 29.6 34.2 32.6 32.4 32.3 32.1 31.7 Goods exports (percent of GDP) 9.3 6.8 6.0 6.7 6.3 6.4 6.5 Goods imports (percent of GDP) 31.6 27.0 27.9 29.7 27.1 26.8 26.6 Net services exports (percent of GDP) 3.2 2.9 5.1 7.9 5.9 6.2 6.4 Trade balance (percent of GDP) -19.1 -17.3 -16.8 -15.1 -14.8 -14.2 -13.7 Remittance inflows (percent of GDP) 7.2 7.4 7.2 6.7 6.3 6.2 6.1 Current account balance (percent of GDP) -10.8 -7.8 -6.8 -6.9 -6.8 -6.6 -6.1 Foreign direct investment inflows (percent of GDP) 8.1 8.0 8.7 9.0 7.3 6.5 6.1 External debt (percent of GDP) 69.6 73.6 73.6 73.6 73.6 73.6 73.6 Real private credit growth (percent, period average) -1.4 -1.8 -2.1 -2.3 n.a. n.a. n.a. Nonperforming loans 22.4 18.2 18.3 13.2 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 17.5 17.1 15.2 13.8 n.a. n.a. n.a. Youth unemployment rate (percent, period average) 32.5 33.2 29.0 25.9 n.a. n.a. n.a. Labor force participation rate 53.7 55.7 57.5 58.3 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 10,645 10,926 11,276 11,693 12,114 12,526 12,964 Poverty rate at US$5.5/day, PPP 37.0 35.4 33.3 31.0 28.4 26.2 24.0 (percent of population) Sources: Country authorities, World Bank estimates and projections. Notes: Youth unemployment rate is for labor force aged 15–29. Albania  |  45 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Bosnia and Herzegovina yy Bosnia and Herzegovina (BiH) has maintained a stable 3 percent annual growth rate for the last few years. Growth in 2018 is projected at 3.2 percent, driven primarily by consumption. In the medium term it is expected to pick up as a new government is elected and structural reforms supported by new investment in infrastructure get underway. yy As a result of a planned increase in public investment, in 2018 the fiscal stance is expected to deteriorate, followed by gradual improvement over the medium term; this forecast assumes the success of reforms to reduce the public wage bill and shift jobs from the public to the private sector. yy Risks to this outlook are mostly on the downside. Externally, slow growth in the EU and accession prospects, possible tightening of financing conditions for emerging markets, as well as regional political situation are the main downside risks. Domestically, delays in forming the new government after the October general election could slow reform efforts and drag down growth. Recent Economic Developments from 20.5 percent in 2017 to 18.4 percent, driven by rising demand for labor and a fall Growth in 2017 was an estimated 3 percent, in the activity rate.1 The employment rate has rising to an estimated 3.2 percent in 2018. risen from 33.9 percent in 2017 to 34.3 percent Consumption continues to be the dominant this year, though that is still low for a Western driver of growth, adding 3.5 pp, followed by Balkan country. Most of the jobs improvement investment (0.8 pp). Net exports, however, originated in industry and services; in agriculture are expected to subtract 1.1 pp from growth. employment went down in absolute terms. In the first half of the year, external demand The long-term unemployment rate decreased helped push up export growth by 12 percent, by 2 pp but is still 80 percent. Despite stable but an 8 percent rise in imports offset export economic growth for the last three years, there momentum. The main exports are mineral have been only modest gains in employment. products, base metals, and machinery, which Addressing structural rigidities will be crucial together contributed 69 percent to growth in if BiH is to accelerate and solidify gains in job exports. Growth in imports was broad-based creation. and mainly driven by the same three categories, followed by chemical products, plastics, and Prices have picked up. In 2017 the consumer rubber, which together explain 70 percent of price index rose on average by 0.8 percent. A long the growth in imports. winter, a rebound of global energy markets, and the increase in excise duties pushed up prices The unemployment rate remains high, although the labor market has improved somewhat. The unemployment rate has fallen 1 2018 Labor Force Survey. 46  |  Bosnia and Herzegovina HIGHER BUT FRAGILE GROWTH for fuel and imported food in the first half of equity was 11.9 percent and capital adequacy the year; tobacco prices also went up. By June was relatively stable at 15.4 percent. Capital 2018 these had led to a 1.9 percent increase in buffers are within regulatory requirements. consumer prices year on year (y-o-y). Given the limited growth in nominal salaries, in 2018 The current account deficit (CAD) narrowed higher consumer prices will most likely reduce slightly in 2017 but is expected to widen real incomes. in 2018. The CAD went from 5.1 percent in 2016 to 4.8 percent in 2017 based on strong In 2018, a fiscal deficit higher by 0.5 percent growth in exports (up by 16.1 percent) and of GDP is expected. The fiscal account has a somewhat slower rise in imports (up by been in surplus for several years. A surplus of 12.4 percent). In 2018, however, net exports 2.4 percent of GDP is estimated for 2017, up are expected to subtract from growth, mainly from a 1 percent surplus in 2016.2 This increase because imports have started to pick up but is mainly the result of higher collection of tax exports of some commodities, such as fruit, revenues, although combined with higher social are growing more slowly. For example, the spending and some recovery of capital spending. export of apples to Russia was disrupted in In 2018, both tax revenues and spending on January due to violation of a rules of origin wages, social transfers, and investment are agreement, but by mid-year the agreement expected to increase lending, causing a deficit was back in force. Other components of the of 0.5 percent of GDP. Reaching agreement on current account, such as services surplus from the Global Fiscal Framework for 2019–21 by transport, travel, construction, and remittances midyear is an important milestone; it has created were almost unchanged and were sufficient to a positive precondition for timely adoption finance a significant part of the trade deficit. in this election year of the budgets for 2019. The rest is financed mainly by other investment Total public debt in 2017 was 36.1 percent and FDI. It is estimated that in 2018 FDI will of GDP (of which external was 30.6 percent) cover 40 percent of the CAD, with the rest and consisted largely of concessional debt to coming from new borrowing. A recent Debt international financial institutions. The total Sustainability Analysis rated BiH as moderately external debt-to-GDP ratio is projected to indebted. remain at about 70 percent in 2018. The banking sector is liquid and well- Outlook and Risks capitalized. Though still high, the system-wide nonperforming loan (NPL) ratio is heading Supported primarily by rising domestic down. At the end of the first quarter, the demand, economic growth is projected to share of NPLs in commercial bank portfolios build from 3.2 percent in 2018 to 3.9 percent reached 9.7 percent of total loans, down from by 2020. As a new government is elected 10 percent at the end of 2017. Profitability has and reform activities accelerate, a moderate been improving—in the first quarter return on rise in growth is expected, with likely higher investment in infrastructure. A rise in exports is also expected, but strong demand for imports 2 See BiH Global Fiscal Framework 2019–21. for infrastructure projects may outpace export Bosnia and Herzegovina  |  47 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 growth. Remittances are likely to hold steady and support a gradual pickup in consumption. Investments will support job creation in energy, construction, and tourism. Real GDP growth is therefore projected to build gradually to 3.9 percent by 2020. Achieving efficient and effective fiscal policy is still a major challenge as the country strives to address persistent unemployment. Although recently the fiscal account has been mostly in surplus, the high tax burden deters job creation, and public spending is inefficient. Despite good fiscal outcomes, continuing accumulation of arrears, structural rigidities on the spending side manifest in a high public wage bill and poor targeting of social assistance suggest that better public finance management could improve the efficiency of public spending. With elections forthcoming, this may be a key challenge for the new government. Both domestic and external risks persist. The main domestic risk may be the October general elections and the possibility of delays in forming the government. That might hold back the reform agenda. Progress toward becoming a WTO member, however, suggests that improvements in trade may boost growth. On a positive side, BiH is expecting to receive a ruling answer on its candidate status from the European Commission within the next calendar year. Externally, slow growth in the EU and accession prospects, possible tightening of financing conditions for emerging markets, as well as regional political situation are the main downside risks. 48  |  Bosnia and Herzegovina HIGHER BUT FRAGILE GROWTH Annual GDP growth continued at 3 percent, Consumer price inflation was moderate in led by services. 2018 but oil prices rose in the first half of the year. Contributions to growth, percentage points of GDP Percent y-o-y Euro 3.5 9 90 3.0 70 2.5 5 2.0 50 1.5 1 30 1.0 -3 0.5 10 0 -7 -10 -0.5 -11 -1.0 -30 -1.5 -15 -50 -15 -15 -15 -16 -16 -16 -17 -17 -17 -18 -18 2012 2013 2014 2015 2016 2017f 2018f Jan May Sep Jan May Sep Jan May Sep Jan May JJ Agriculture JJ Industry JJ BiH overall CPI inflation, lhs ▬▬ BiH transport CPI inflation, lhs JJ Services QQ Overall GDP growth ▬▬ Change in Brent oil price, rhs Source: BiH Agency for Statistics; World Bank staff estimates. Source: BiH Agency for Statistics; World Bank staff estimates. Collection of indirect tax revenues slowed at The fiscal balance is expected to turn to deficit mid year. in 2018. Real 3 months moving average, percent y-o-y General government fiscal balance, percent of GDP 14 3 12 10 2 8 6 4 1 2 0 0 -2 -4 -1 -15 Jul- 15 -16 Jul- 16 -17 Jul- 17 -18 -18 Jan Jan Jan Jan Jun 2015 2016 2017e 2018f 2019f 2020f 2021f ▬▬ Growth in total indirect revenues, in 2010 prices ▬▬ Growth in net indirect revenues, in 2010 prices Source: BiH Indirect Tax Office; World Bank staff estimates. Source: Fiscal authorities; World Bank staff estimates. The deficit in the goods trade continued to Nonperforming loans in commercial bank widen. portfolios are high and deleveraging is still a risk. KM billions, 12m sum 3 mo. moving ave., % y-o-y Percent 30 8 18 16 20 14 4 12 10 10 0 0 8 6 -10 4 -4 2 -20 0 -30 -8 -2 -15 Jul- 15 -16 Jul- 16 -17 Jul- 17 -18 un-18 13 13 14 14 15 15 16 16 17 17 18 Jan Jan Jan Jan J Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- Q3- Q1- JJ Trade balance, lhs ▬▬ Exports, rhs ▬▬ Imports, rhs JJ Capital adequacy, tier 1 capital to risk weighted assets ▬▬ Asset quality, NPLs to total loans ▬▬ Profitability, Return on Equity Source: BiH Agency for Statistics; World Bank staff estimates. Source: Central Bank of BiH, World Bank staff estimates. Bosnia and Herzegovina  |  49 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 BOSNIA AND HERZEGOVINA 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) 1.1 3.0 3.1 3.0 3.2 3.4 3.9 Composition (percentage points): Consumption n.a. n.a. n.a. 3.0 3.5 2.6 2.7 Investment n.a. n.a. n.a. 0.6 0.8 1.0 0.8 Net exports n.a. n.a. n.a. -0.8 -1.1 -0.2 0.4 Exports n.a. n.a. n.a. 4.2 1.7 1.7 1.3 Imports (-) n.a. n.a. n.a. 5.1 2.7 2.0 0.9 Consumer price inflation (percent, period average) -0.9 -1.0 -1.6 0.8 1.1 1.4 1.4 Public revenues (percent of GDP) 44.2 43.2 43.1 43.7 44.5 42.9 42.7 Public expenditures (percent of GDP) 46.2 42.5 42.1 41.4 45.0 42.6 41.5 Of which: Wage bill (percent of GDP) 12.1 11.5 11.0 11.0 11.1 10.9 10.6 Social benefits (percent of GDP) 17.2 16.5 17.7 17.8 18.3 17.1 16.7 Capital expenditures (percent of GDP) 4.3 2.0 2.4 2.3 5.0 4.3 4.1 Fiscal balance (percent of GDP) -2.1 0.7 1.0 2.4 -0.5 0.3 1.2 Primary fiscal balance (percent of GDP) -1.2 1.6 1.9 3.2 0.5 1.3 2.2 Public debt (percent of GDP) 42.0 41.9 42.4 36.1 35.1 34.0 33.2 Public and publicly guaranteed debt 43.1 43.2 43.3 38.0 36.7 35.6 34.8 (percent of GDP) Of which: External (percent of GDP) 34.7 35.0 35.9 30.6 29.8 29.0 28.4 Goods exports (percent of GDP) 25.1 25.2 25.7 28.5 31.2 33.9 35.2 Goods imports (percent of GDP) 53.9 50.3 49.3 52.3 55.9 59.1 60.8 Net services exports (percent of GDP) 6.1 6.4 6.4 7.1 8.0 8.3 8.4 Trade balance (percent of GDP) -22.7 -18.8 -17.1 -16.7 -16.7 -17.0 -17.2 Remittance inflows (percent of GDP) 8.5 8.3 8.2 8.3 8.2 8.3 8.4 Current account balance (percent of GDP) -7.4 -5.7 -5.1 -4.8 -5.3 -5.5 -5.6 Foreign direct investment inflows (percent of GDP) 2.9 1.7 1.6 2.1 2.1 2.2 2.3 External debt (percent of GDP) 77.1 72.2 71.0 70.3 69.3 68.8 68.8 Real private credit growth (percent, period average) 4.1 2.3 4.2 4.9 n.a. n.a. n.a. Non-performing loans 14.0 13.7 11.8 10.0 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 27.5 27.7 25.4 20.5 18.4 n.a. n.a. Youth unemployment rate (percent, period average) 62.9 62.2 54.5 45.8 n.a. n.a. n.a. Labor force participation rate 43.7 44.1 43.0 42.6 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 11,164 11,526 12,173 12,875 13,200 13,775 14,258 Poverty rate at US$5/day, PPP n.a. n.a. n.a. n.a. n.a. n.a. n.a. (percent of population) Sources: Country authorities, World Bank estimates and projections. Notes: Non-performing loans show year-to-date actuals. 50  |  Bosnia and Herzegovina HIGHER BUT FRAGILE GROWTH Kosovo3 yy Growth is projected to reach 4.0 percent in 2018, up from 3.7 percent in 2017 and driven by investment, services exports, and a recovery in consumption. yy The fiscal deficit is expected to reach 2.4 percent of GDP in 2018 as rapid growth in untargeted social spending and public wages and accelerated public investment outpace revenue growth. yy The outlook is positive, with growth averaging 4.5 percent for 2019–20, but the upturn is subject to major risks related to possible tightening of financial conditions for emerging markets and growth in the EU, domestic and regional political dynamics, the speed of execution of public investments, and the stability of metals production and prices. Main Developments and Trends 0.3 pp, and industry only 0.1 pp, down from 0.6 pp in 2017 as base metal production slows. Growth is expected to reach 4 percent in 2018, up from 3.7 percent in 2017, driven mainly Net job creation was negative in the by public and private investment, services first half of 2018, after fast pick-ups in exports, and a recovery in consumption. employment in 2016 and 2017. In the first Investment, both public and private, is half of 2018, employment fell by 1.4 pp y-o-y. projected to add 2.1 percentage points (pp) Unemployment also declined by 1.2 pp as to growth. Private investment is expected to labor force participation fell by 2.6 pp. Youth increase less this year than last because in the unemployment rose to 55 percent, up 4.1 pp first half of 2018 FDI fell. Despite the fast rise y-o-y. Over 70 percent of those unemployed in services exports, net exports are expected to have been seeking a job for over a year, and at add a mere 0.4 pp to growth, as Ferronikeli 28.5 percent of the working-age population, production has halted and imports related employment is low. It is not yet clear whether to investment have risen. Consumption has this trend will continue in 2018. recovered in part after last year’s unexpected negative contribution of 1.6 pp and is expected A fiscal deficit of 2.4 percent is expected in to contribute 1.5 pp. Expansion in services 2018, doubling from 1.2 percent in 2017 (accommodation, transport, financial activity, and driven by higher capital investment and construction) is expected to add 3.3 pp, and growing untargeted social protection up from 1.4 pp in 2017. As in the last two spending. Total spending is projected to grow years, agriculture is expected to contribute just by 9.2 percent, including 7.4 percent growth in current spending for higher transfers, goods and services, and wages; and 16.3 percent growth 3 The note is based on the data made available as of the time of report’s preparation, August, 2018 and GDP figures are based in capital spending. Social protection spending on the quarterly estimates. The current annual estimate for 2017 will increase by 7.8 percent: payments for war GDP growth based on September 2018 GDP data release is at 4.2 percent. veterans will exceed budget as amendments Kosovo  |  51 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 to the law to contain the costs were not (due to the shut-down of the Ferronikeli plant, implemented. New capital projects, fueled by the biggest exporter of base metals in Kosovo), additional funds from the Privatization Agency and a 10 percent increase in imports, mainly and commencement of railway and other for investment projects. IFI-financed projects, are likely to accelerate execution of the capital budget. Revenues are Surprisingly, net FDI fell by 40 percent y-o-y also expected to increase by 5.1 percent y-o-y in the first half of 2018, though remittances in 2018. The projections are for indirect tax again grew. Among reasons for the FDI decline revenues to grow by 4.5 percent (VAT by were weaker performance by foreign firms and 6.6 percent); non-tax revenues to be almost flat higher repatriation of profits for debt repayment, at 0.2 percent growth; and direct tax revenues which reduced the scope for reinvestment to grow by 9.8 percent, driven by a 10 percent of earnings. There were net FDI outflows in increase in corporate income taxes. By yearend, construction, mining, and manufacturing. public and publicly guaranteed debt is projected Though still positive, net inflows in financial at 18 percent of GDP, is growing fast due to intermediation also declined. Strong growth in higher primary budget deficits. remittances supplemented FDI in covering the domestic savings shortfall. In the first half of 2018 investment and consumption rose due to higher credit growth. As in 2017, better market conditions Outlook and lower interest rates led to higher private credit (11.3 percent). Corporate loans grew Economic growth in Kosovo is projected by 11.2 percent, mostly to the service sector, to reach 4.5 percent in the medium term, namely wholesale and trade, construction, and propelled by higher capital spending and a other services, followed by manufacturing, recovery in consumption. The government is while loans to households grew even faster at preparing railway and regional road projects. 11.9 percent. NPLs declined further to reach The enhanced business climate, higher FDI, 2.7 percent of loans by end-July. and optimism in the EU are likely to encourage private investment. Higher wages, social Average inflation is expected to moderate to spending, remittances, and credit to households about 0.7 percent. The main driver is the rise should lead household consumption and in food and transport prices—housing, energy, by 2020 add 1.6 pp to growth. Exports are clothing, and communications prices declined. likely to benefit from robust growth in the EU and higher prices for base metals, but net The current account deficit (CAD) is exports are expected to subtract 0.8 pp from expected to go up to 6.9 percent in 2018 due growth because of higher imports for public to an unexpectedly strong increase in imports investments. and a halt in nickel production. Driven by tourism exports, financed by the diaspora, net In 2019, higher growth can stimulate creation exports of services contributed positively but of services, construction, and manufacturing were offset by an unexpected pick-up in services jobs. However, if more people enter the labor imports, a 3 percent decline in exports of goods market, unemployment might also rise. 52  | Kosovo HIGHER BUT FRAGILE GROWTH Higher current and capital spending is To counterbalance these risks, r  eforms should expected to raise the 2019 fiscal deficit to focus on preserving fiscal sustainability by 2.9 percent. Collection of more revenues is avoiding unfunded increases in social protection expected to be offset by higher current and spending and allocating spending to items that capital spending on IFI- and PAK-financed may increase output, shift resources to tradable projects; higher costs for wages, goods, and sectors, increase productivity, engage and services; and higher subsidies and transfers for employ youth and women, address corruption, veteran benefits and targeted social assistance. improve environmental sustainability, and The deficit of 1.9 percent of GDP, excluding address infrastructure constraints. investment clause projects, will adhere to the fiscal rule. In the medium term the CAD is expected to widen to about 9 percent of GDP as more investment goods are imported. Heightened demand for investment goods implies higher capital spending, but growth in FDI and remittances should cover the gap. This positive outlook is vulnerable to risks related to domestic and regional political developments, lower production and prices of base metals, and lower than expected growth in Europe. Any delay in reforms, e.g., to cap war veteran benefits or to prevent rises in untargeted social benefits and unfunded early retirement options, plus uncertainties about the draft law on public wages and salaries, could increase fiscal pressures and reduce the potential for productive government spending. Project delays can also raise costs. The expansion of public investment may suffer from capacity constraints. Lower than expected growth in the Euro Area might reduce remittances and FDI, and exports and lower base metal prices and production might expand the CAD. Finally, the possible tightening of the financing conditions for emerging markets could impact Kosovo as well, including through spillovers from the region. Kosovo  |  53 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Investment and recovery in consumption were Services are likely to continue to be the main the main reasons behind higher growth in engine of growth in 2018, and beyond. 2018. Growth contributions, percent Growth contributions, percent 8 5 6 4 4 3 2 2 0 -2 1 -4 0 2016 2017 2018e 2019f 2020f 2016 2017 2018e 2019f 2020f JJ Consumption JJ Investments JJ Net exports ▬▬ Growth JJ Agriculture JJ Industry JJ Services JJ Taxes less subsidies ▬▬ Real GDP growth Source: Statistics Agency of Kosovo and World Bank. Source: Statistics Agency of Kosovo and World Bank. Higher public investment, IFI-financed projects, FDI outflows in manufacturing and and transfers will raise budget deficits. construction led to a decline in FDI in the first half of 2018. Percent of GDP Million euros, nominal 32 0 160 31 -0.5 140 30 -1.2 -1.0 120 29 -1.4 -1.5 100 28 80 -2.0 60 27 40 26 -2.5 -2.4 20 25 -2.8 -3.0 0 24 -3.5 -20 -3.5 -4.0 -40 23 2016 2017 2018 2019 2020 H1 2017 H1 2018 ▬▬ Public revenues, lhs ▬▬ Public expenditure, lhs ▬▬ Budget balance, rhs JJ Agriculture, hunting, forestry, fishing JJ Manufacturing JJ Construction JJ Wholesale, retail trade, repair of motor vehicles, etc. JJ Other JJ Financial intermediation JJ Real estate, renting, business activities Source: Ministry of Finance and World Bank. Source: Central Bank of Kosovo and World Bank. Recent improvements in the labor market Credit growth again supports growth in private began to reverse in H1 2018, but that may not investment and consumption. continue. Percent Percent y-o-y growth of outstanding credit 60 18 55 16 50 14 45 12 10 40 8 35 6 30 4 25 2 20 0 16 2-16 3-16 4-16 1-17 2-17 3-17 4-17 1-18 2-18 -14 Jul-14 an-15 Jul-15 an-16 Jul-16 an-17 Jul-17 an-18 Jul-18 Q1- Q Q Q Q Q Q Q Q Q Jan J J J J ▬▬ Labor force participation ▬▬ Employment rate ▬▬ Unmployment rate ▬▬ Total loans ▬▬ Loans to corporations ▬▬ Loans to households ▬▬ Youth unemployment rate Source: Statistics Agency of Kosovo and World Bank. Source: Central Bank of the Republic of Kosovo. 54  | Kosovo HIGHER BUT FRAGILE GROWTH KOSOVO 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) 1.2 4.1 4.1 3.7 4.0 4.5 4.5 Composition (percentage points): Consumption 3.8 2.5 4.7 -1.6 1.5 1.8 2.0 Investment -1.4 2.9 2.1 2.9 2.1 3.6 3.2 Net exports -1.2 -1.3 -2.7 2.5 0.4 -0.9 -0.7 Exports 2.9 0.5 0.5 5.3 4.5 4.1 3.6 Imports (-) 4.1 1.8 3.2 2.8 4.1 5.0 4.3 Consumer price inflation (percent, period) average) 0.4 -0.5 0.3 1.5 0.7 1.5 1.6 Public revenues (percent of GDP) 24.0 25.1 26.3 27.0 27.5 27.4 27.7 Public expenditures (percent of GDP) 26.6 27.1 27.7 28.2 29.9 30.2 31.2 Of which: Wage bill (percent of GDP) 8.7 9.0 9.0 8.8 9.0 8.9 8.8 Social benefits (percent of GDP) 5.0 5.4 6.1 6.2 6.5 6.0 5.8 Capital expenditures (percent of GDP) 7.4 7.0 7.2 7.5 8.4 9.5 10.6 Fiscal balance (percent of GDP) -2.6 -2.0 -1.4 -1.2 -2.4 -2.9 -3.5 Primary fiscal balance (percent of GDP) -2.4 -1.7 -1.1 -1.0 -2.0 -2.5 -3.1 Public debt (percent of GDP) 10.4 12.7 14.1 15.9 17.2 18.6 20.1 Public and publicly guaranteed debt 10.6 12.8 14.4 16.6 18.0 19.3 20.8 (percent of GDP) Of which: External (percent of GDP) 5.8 6.2 6.2 6.8 6.7 6.9 7.3 Goods exports (percent of GDP) 5.8 5.6 5.1 6.0 5.6 5.6 5.7 Goods imports (percent of GDP) 42.8 41.9 42.8 45.3 48.2 50.3 51.8 Net services exports (percent of GDP) 8.3 7.9 10.5 12.8 15.0 17.3 19.4 Trade balance (percent of GDP) -28.7 -28.5 -27.2 -26.4 -27.6 -27.4 -26.8 Remittance inflows (percent of GDP) 9.9 10.5 10.5 11.3 11.9 12.1 12.5 Current account balance (percent of GDP) -6.9 -8.6 -7.9 -6.6 -6.9 -8.5 -9.0 Foreign direct investment inflows (percent of GDP) 2.2 4.7 2.9 4.0 1.9 3.2 3.6 External debt (percent of GDP) 31.2 33.3 32.7 33.4 34.4 34.6 35.2 Real private credit growth (percent, period average) 3.2 7.9 8.7 8.8 n.a. n.a. n.a. Nonperforming loans 8.5 6.5 4.9 3.1 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 35.3 32.9 27.5 30.4 n.a. n.a. n.a. Youth unemployment rate (percent, period average) 61.0 57.7 52.4 52.7 n.a. n.a. n.a. Labor force participation rate 41.6 37.6 38.7 42.8 n.a. n.a. n.a. (percent, period average) GDP per capita (current US$) 4,055 3,745 3,698 3,876 3,982 4,297 4,473 Poverty rate at US$5/day, PPP n.a. n.a. n.a. n.a. n.a. n.a. n.a. (percent of population) Sources: Country authorities, World Bank estimates and projections. Kosovo  |  55 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 FYR Macedonia yy Growth is projected to rebound to 2.5 percent in 2018, driven by consumption and an investment recovery based on investor confidence, which rose as political stability was restored. yy Labor market performance improved, and unemployment fell to a historical low. Although higher than in most Western Balkan countries, by EU standards employment and labor force participation rates are low. yy The fiscal deficit narrowed, largely due to the significant under-execution of capital spending. Nevertheless, by June 2018, public debt had gone up. yy Accelerating and sustaining growth without jeopardizing fiscal sustainability should be a priority. This will require a credible fiscal strategy to prevent more growth in public debt and structural reforms to bring about long-term employment gains through higher productivity, improved human capital, and enhanced quality of public services. yy Risks to the outlook are moderate. Externally, slow growth in the EU and accession prospects, possible tightening of financing conditions for emerging markets, as well as regional political situation are the main downside risks. Recent Economic Developments The labor market continued to improve, helped in part from employment subsidies. In 2018 the Macedonian economy is In the first half of 2018, employment grew rebounding from stagnation as exports, by 2.1 percent y-o-y. Most of the jobs consumption, and investments recover. created were in manufacturing and food Manufacturing grew by 5.6 percent y-o-y in and accommodation services, followed by the first six month of 2018, largely in FDI- construction and professional services. The intensive sectors. Meanwhile, local industries subsidies for the Employment Program, like mining, apparel, metal, and non-metal including for subsidizing the rise in minimum products declined. Continuing its negative wages, almost doubled by July 2018 compared trend, construction fell by more than 25 percent to the same period last year. Even though the y-o-y in real terms as road construction slowed. employment rate improved to 44.9 percent However, private investments (proxied by civil in the second quarter, more than half of engineering works) started growing after 12 Macedonians of working-age are either still consecutive months of decline. Propelled by unemployed or are not looking for work. The rising wages, pensions, and household lending, unemployment rate fell to a historical low of retail trade continued growing and tourism had 21.1 percent in June and is projected to decline a record-breaking year. With investment and further, to 20.4 percent, for the year. The share consumption recovering, by year-end growth of long-term unemployed at 78 percent (81 is projected to jump from zero in 2017 to percent in 2017) reflects structural issues in the 2.5 percent. labor market. Youth unemployment (age 15– 56  |  FYR Macedonia HIGHER BUT FRAGILE GROWTH 24) was 47.6 percent, up slightly from a year Monetary policy has become even more ago. Led by the rise of the minimum wage in accommodative. During 2018, the Central September 2017, net wages rose by an average Bank lowered the key interest rate by 25 bps of 5.5 percent y-o-y. The largest increase, over in two consecutive steps, bringing it down 10 percent, was in low-earning labor-intensive to 2.75 percent. The interest rate cut reflects sectors. favorable changes in the foreign exchange market, led by an improved external position, The fiscal deficit is expected to decline a rise in deposits, and economic stagnation in in 2018 as revenue grows and capital early 2018 despite the positive expectations investment drops. By July 2018, revenues had of economic agents. Inflation has risen in gone up by 4.6 percent y-o-y, paced by social 2018, reaching 1.5 percent y-o-y by July, as contributions, excises, and higher corporate prices went up for food, beverages, and energy and personal income tax receipts. Net VAT (including oil). Core inflation was still low at revenues also went up, despite a surge in VAT 1.3 percent y-o-y in July, which suggests that refunds to clear arrears to the corporate sector. economic activity is still below potential. Spending increased by only 1.3 percent y-o-y, largely driven by the drop in capital spending, Credit grew in 2018, mostly targeted to despite an already low 2017 base. On the other households. By July household credit had hand, current spending increased by 5.7 percent grown by 10 percent y-o-y; with the economy y-o-y, led by social transfers and employment still recovering, corporate lending grew by subsidies to firms to compensate for the rise in 2.6 percent. Recent improvements in bank the minimum wage. The budget deficit declined assets, with corporate nonperforming loans to 2.1 percent of GDP (on a 12-month rolling (NPLs) having declined from 9.8 percent in basis) compared to 2.7 percent in 2017. The 2017 to 7.8 percent in July 2018, while all expected deficit for 2018 is 2.6 percent—or 3.2 NPLs dropping from 6.2 to 5.1 percent, which when the finances of the Public Enterprise for helped spur lending. The survey of credit State Roads are included. activity reports lower credit requirements and higher credit demand from companies. Despite the lower deficit, new borrowing pushed up public debt. Public and publicly The external balance is still stable. The current guaranteed (PPG) debt had risen from account deficit (CAD) is expected to decrease 47.6 percent in 2017 to 49.1 percent by June marginally from 1.3 percent of GDP in 2017 to 2018. The increase is due to issuance of a new 1.2 percent. The solid performance of car-parts Eurobond—at the historically-best terms for a exports, along with iron and steel, furniture, 7-year €500 million bond of 2.75 percent— and tobacco, left the goods and services trade that fully covers government borrowing deficit largely unchanged, even though imports requirements for 2018. On the other hand, have risen by double digits. Net private inflows guaranteed debt declined as a percent of GDP went up sufficiently to cover the entire goods from 8.2 to 8 percent as disbursements of the and services trade deficit. The deficit in the Chinese loan for constructing highways slowed. primary income balance widened marginally PPG debt is expected to reach 50.6 percent of due to interest payments and repatriated profits. GDP by yearend. FYR Macedonia  |  57 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 FDI is projected to increase from 2.3 percent of Accelerating and sustaining growth without GDP in 2017 to 3.0 percent in 2018. jeopardizing fiscal sustainability is critical. Credible medium-term fiscal consolidation is necessary to reduce the fiscal deficit and Outlook and Risks stabilize the public debt-to-GDP ratio. The country’s growth strategy must move away from The economic outlook is positive, and it is reliance on fiscal stimulus to support individual expected that, by 2020, growth will have firms and make structural reforms that produce gradually risen to 3.2 percent. Spurred long-term job gains by boosting human capital by recovering investments, an improved and firm productivity. To mitigate medium- political climate, and the end of technical and long-term demographic pressures, reforms difficulties that interrupted the construction of pensions and health care are needed to of two highways, construction is expected overcome the structural challenges both systems to recover. Manufacturing is also expected to must deal with. Finally, public spending must grow, propelled by external demand. Private be made more efficient so that better public consumption is projected to rise with higher services can be delivered more effectively. wages and employment, rising credit to households, and also, as the new authorities indicated, a rise in social transfers. This baseline scenario is conditional on the success of the agreement with Greece on resolution of the country’s name dispute and revival of the NATO and EU membership processes. Externally, slow growth in the EU and accession prospects, possible tightening of financing conditions for emerging markets, as well as regional political situation are the main downside risks. Political stability and related business optimism give policymakers an opportunity to tackle critical longer-term development priorities. The current government, in office since June 2017, has embarked on a new reform program and has already made progress in implementing a Public Financial Management Reform Strategy, making public finances more transparent and deregulating the energy sector. However, EU accession negotiations will require a broad-based reform effort if FYR Macedonia is to catch up with the frontrunners. 58  |  FYR Macedonia HIGHER BUT FRAGILE GROWTH Economy started recovering by mid-2018… …and should further strengthen as suggested by high-frequency indicators. Percent Trade cycle, percent, index, 2011=100 5 150 300 4 3 250 2 100 200 1 0 150 -1 -2 50 100 -3 50 -4 -5 0 0 16 16 16 16 1-17 2-17 3-17 4-17 1-18 2-18 0 1 2 3 4 5 6 7 8 Q1- Q2- Q3- Q4- Q Q Q Q Q Q 201 201 201 201 201 201 201 201 201 JJ Agriculture JJ Mining, electricity, gas supply JJ Manufacturing ▬▬ Industry_tc ▬▬ Retail trade_tc JJ Construction JJ Wholesale & retail, transportation, accommodation ▬▬ Tourism_tc ▬▬ Construction_tc, rhs JJ Other services ▬▬ Real GDP growth Source: State Statistics Office. Source: State Statistics Office and World Bank estimates. External deficit narrowed due to surge in Labor market improved, with unemployment at exports. a historic low. Percent of GDP Percent 30 70 65 20 60 57 52 10 50 46 0 40 37 45 -10 30 33 -20 21 -30 20 8 004 006 008 010 012 014 016 201 2010 2011 2012 2013 2014 2015 2016 2017 2018 2 2 2 2 2 2 2 H1 JJ Goods JJ Services JJ Income JJ Current transfers ▬▬ Unemployment rate ▬▬ Employment rate ▬▬ Current account balance ▬▬ Activity rate ▬▬ Youth unemployment Source: National Bank data. Source: State Statistics Office. Continued credit expansion is mainly targeted Although the deficit declined, public debt to households. resumed growth. Percent Yearly change, percent Percent of GDP 100 10 50 90 80 8 40 70 60 6 30 50 40 4 20 30 20 2 10 10 0 0 0 15 15 15 15 16 16 16 16 17 17 17 17 18 18 2 4 6 8 0 2 4 6 018 Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- 200 200 200 200 201 201 201 201 Q2 2 JJ Contribution of household loans, lhs JJ Contribution of corporate loans, lhs JJ Domestic debt JJ Foreign debt JJ Guarantees ▬▬ Credit growth, rhs Source: National Bank data. Source: Ministry of Finance and World Bank estimates. FYR Macedonia  |  59 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 FYR MACEDONIA 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) 3.6 3.9 2.9 0.0 2.5 2.9 3.2 Composition (percentage points) Consumption 2.0 3.7 2.5 1.8 1.4 1.2 1.0 Investment 2.9 2.6 4.4 -1.1 0.4 1.5 2.1 Net exports -1.3 -2.5 -4.0 -0.7 0.7 0.2 0.1 Exports 7.3 4.2 4.2 5.0 5.0 4.9 4.9 Imports 8.7 6.7 8.3 5.7 4.3 4.7 4.8 Consumer price inflation (percent, period average) -0.2 -0.3 -0.2 1.3 1.6 2.0 2.0 Public revenues (percent of GDP) 29.7 31.0 30.3 30.9 32.0 32.7 32.8 Public expenditures (percent of GDP) 33.9 34.4 33.0 33.7 34.6 35.3 35.4 Of which: Wage bill (percent of GDP) 7.0 7.0 6.8 6.6 6.9 6.9 6.7 Social transfers (percent of GDP) 15.3 15.3 15.3 15.8 15.7 15.8 15.8 Capital expenditures (percent of GDP) 4.2 4.2 3.8 4.1 3.7 4.1 4.3 Fiscal balance (percent of GDP) -4.2 -3.4 -2.7 -2.8 -2.6 -2.6 -2.6 Overall Fiscal Balance with the Public Enterprice -5.3 -4.1 -3.8 -3.4 -3.2 -3.1 -3.1 for State Roads included Primary fiscal balance (percent of GDP) -3.2 -2.3 -1.5 -1.5 -1.2 -1.1 -0.9 Public debt (percent of GDP) 38.1 38.1 39.6 39.3 42.4 43.5 44.2 Public and publicly guaranteed debt 45.7 46.6 48.4 47.6 50.6 55.7 58.3 (percent of GDP) Of which: External (percent of GDP) 32.1 31.6 33.9 31.9 36.3 43.1 44.7 Goods exports (percent of GDP) 32.5 33.6 35.7 40.4 42.7 44.6 46.3 Goods imports (percent of GDP) 54.2 53.7 54.3 58.2 60.3 62.3 63.8 Net services exports (percent of GDP) 4.5 3.8 3.6 4.0 4.3 4.6 4.9 Trade balance (percent of GDP) -17.2 -16.2 -15.0 -13.9 -13.3 -13.1 -12.5 Remittance inflows (percent of GDP) 2.4 2.3 2.0 1.9 1.9 1.9 1.9 Current account balance (percent of GDP) -0.5 -2.0 -2.7 -1.3 -1.2 -1.4 -1.5 Net foreign direct investment inflows 2.3 2.2 3.3 2.3 3.0 3.1 3.2 (percent of GDP) External debt (percent of GDP) 69.6 68.5 72.0 72.7 77.4 78.2 78.9 Real private credit growth (percent, period average) 8.5 9.4 7.8 4.2 n.a. n.a. n.a. Non-performing loans 11.1 10.6 6.4 6.2 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 28.0 26.1 23.7 22.4 20.4 19.4 18.0 Youth unemployment rate (percent, period average) 53.1 47.3 48.3 46.8 n.a. n.a. n.a. Labor force participation rate 57.5 57.2 56.8 57.2 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 22,002 22,514 22,998 23,493 23,998 24,514 25,041 Poverty rate at US$5/day, PPP 24.8 23.2 21.9 21.0 20.7 20.5 20.5 (percent of population) Sources: Country authorities, World Bank estimates and projections. Notes: Poverty rates are based on FYR Macedonia survey on income and living conditions (SILC). 60  |  FYR Macedonia HIGHER BUT FRAGILE GROWTH Montenegro yy The 2018 growth projection was revised upward to 3.8 percent as both private and public investments surged, and tourism recorded another historical high. yy Employment growth resumed in mid-2018, led by tourism, construction, and trade, and helped reduce administrative unemployment by double digits. yy Medium-term refinancing pressures subsided with the successful Eurobond issuance as Montenegro’s credit outlook improved to stable. yy While tax increases led the fiscal consolidation, spending restrictions have been delayed despite the high deficit and high public debt. Fiscal vulnerability, although declining, is still high, calling for public administration and social sector reforms to accelerate. yy Risks to the outlook are mostly on the downside. Externally, slow growth in the EU and accession prospects, possible tightening of financing conditions for emerging markets, as well as regional political situation are the main downside risks. Domestically, the pace of fiscal consolidation and ability to reduce debt are key risks. Recent Economic Developments Higher growth has stimulated job creation in the private sector. After slowing in the Montenegro’s economy again grew robustly second half of 2017, by mid-2018 employment in 2018. The growth projection for the year growth had picked up again. Employment has been revised upward as both private and grew by 1.6 percent y-o-y by June 2018, led public investment surged, and exports of goods by manufacturing, construction, tourism, and services expanded. Investment contributed and the public sector. The administrative most to growth in the first quarter as energy unemployment rate finally declined after and tourism investments were accompanied by 5 years of continuous growth but is still above the speed-up in construction of the Bar-Boljare 20 percent, with youth unemployment about highway. Supported by growth in employment double the national average. However, by June and wages, consumption also grew but 2018 the survey-based unemployment rate had decelerated after nine quarters of consecutive declined to a historic low of 15.6 percent (on a growth. Although net exports continued to four-quarter basis), suggesting that informality subtract from growth, strong tourism and is still high. The survey-based employment rate exports of metal goods in response to higher grew to 46.4 percent as both female and male EU demand have offset still-high growth in employment grew. The activity rate stagnated, imports. Tourism, retail trade, and construction however, suggesting that more Montenegrins were again drivers of growth in 2018, but have transitioned from unemployment to inactivity been supplemented by manufacturing and than acquired new jobs. energy, which has doubled production after investments in new capacity in recent years. Montenegro  |  61 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Despite robust growth, at mid-2018 the sector wage dynamics and the rise in the VAT external deficit was unchanged. The current rate and inflation, real gross wages have declined account deficit (CAD) of 16.4 percent of this year. Poverty (measured as consumption GDP by June 2018 (on a four-quarter basis) below the standardized middle-income-country was similar to the revised 2017 annual data. poverty line of $5.5/day 2011 PPP) slid from Imports of goods had gone up by 12.9 percent 8.7 percent in 2012 to an estimated 4.8 percent y-o-y, led by the high import-dependence of for 2018. investments in infrastructure and tourism. Rising imports of cars, furniture, electric Growth in credit to the private sector resumed machinery and equipment, and iron and steel, with the reduction in nonperforming loans however, have been offset by a 21.4 percent (NPLs), growth in deposits, and lower surge in exports of both goods and services, led lending costs. By July 2018 credit to the by steel, aluminum, mineral fuels, wood, and private non-financial sector had grown by tourism. The surplus in the income account 9.4 percent, driven by household lending; declined due to the rise of both dividend however, corporate lending had also recovered payouts and interest payments on rising by 7.1 percent. Continuing the trends, by debt, and the transfer account surplus grew midyear deposits had grown by 15.2 percent as both remittances went up and government y-o-y, suggesting that incomes has risen more disbursement of EU funds accelerated. Net robustly than the wage statistics implied. With FDI inflows declined to 9.3 percent of GDP lending growing, NPLs fell to 7.1 percent, even (on a four-quarter basis), which still covered after application of the stricter international two-thirds of CAD financing. Given the rise in financial reporting standards (IFRS9) that external public debt so far in 2018, the external the banking system transitioned to in January debt-to-GDP ratio will likely grow to exceed 2018. The banking system remained well- 163 percent. capitalized, although some domestic banks continue to show weaknesses and may require Driven by tax rate hikes, in 2018 inflation resolution. rose. Consumer prices had increased by 2.4 percent in 2017 and by August had risen to The fiscal consolidation launched in 2017 2.8 percent y-o-y, tracking the rise in the VAT has started yielding benefits in terms of rate and higher excises on tobacco, alcohol higher revenues, lower spending on social and sugary drinks. and transportation. By July benefits, and a slowdown in growth of the producer prices were up by 2.1 percent, led by public wage bill. The general government a higher cost for oil and higher excises. deficit declined from 2.5 percent of GDP in the first seven months of 2017 to 1.6 percent Poverty reduction slowed in 2018. The poverty in the same period of 2018. However, capital headcount is estimated to have declined in the spending doubled and transfers to the health past few years as economic growth picked up sector shot up; as the system still faces and social transfers surged. In 2018, however, it structural deficit. Issuance of the €500 million will be difficult to significantly reduce poverty, Eurobond and the syndicated €250 million given withdrawal of the mothers’ benefit and loan supported by the World Bank guarantee, the rise in indirect taxes. Also, led by public enabled the government to pre-finance some 62  | Montenegro HIGHER BUT FRAGILE GROWTH debt (€320 million by June) due in 2019–21 pattern. Enhancing policy predictability and and ease its medium-term refinancing needs. accelerating structural reforms is required to By yearend public and publicly guaranteed reduce downside risks and assure the continued debt is expected to rise to 75 percent, up from improvement of growth and labor market 72.5 percent in 2017, as the government builds prospects. up deposits for 2019 financing through the liability management operation. Outlook and Risks The economic outlook is positive, but despite moderation downside risks are still high. The economy is expected to grow by an average of 2.6 percent in 2019–20 because of declining transport investments and personal consumption. As investment slows, so will economic growth, unless productivity gains and new private sector investments unlock Montenegro’s full growth potential. Poverty (at $5.5/day 2011PPP) is expected to again decline in 2019, to an estimated 4.6 percent, subject to improvements in private sector employment and earnings. Externally, slow growth in the EU and accession prospects, possible tightening of financing conditions for emerging markets, as well as regional political situation are the main downside risks. The large fiscal deficit and growing public debt call for sustained implementation of the fiscal consolidation. The 2018 budget revision delayed for a year the initial objective of reaching a balanced budget by 2019 and bringing public debt down to 60 percent by 2020. However, despite easing the 2019–21 refinancing needs, the possibility of tightening financing conditions at international capital markets calls for prompt action to reduce public debt and country’s external imbalances; these are likely to stay high, given the import dependence of Montenegro’s current growth Montenegro  |  63 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Investments led robust growth in 2018. Increased energy and tourism capacity contributed to growth. Contribution to growth, percent High-frequency data, trend-cycle, 2013–18 20 6 180 15 5 160 10 4 5 140 3 0 120 -5 2 1 100 -10 -15 0 80 last observation: Jun-18 15 15 15 15 16 16 16 16 17 17 17 17 18 n -12Jul-12 an-13Jul-13 an-14Jul-14 an-15Jul-15 an-16Jul-16 an-17Jul-17 an-18un-18 Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- J a J J J J J J J JJ Household consumption JJ Government consumption JJ Gross investments ▬▬ Total industry_tc ▬▬ Retail trade_tc ▬▬ Tourism_tc JJ Net exports ▬▬ Real growth Source: MONSTAT data. Source: MONSTAT. Note: Tc = Trend cycle. The labor market improved… …and inflationary pressures have begun to subside. Administrative data, thousands, 2013–18 In thousands 2013–18, annual growth rates 200 55 6 195 50 5 190 4 45 3 185 40 2 180 1 35 175 0 170 30 -1 165 25 -2 last observation: Jun-18 -3 last observation: Jul-18 160 20 1 - -2 1 2 1 - -3 1 3 1 - -4 1 4 1 - -5 1 5 1 - -6 1 6 1 - -7 1 7 1 - -8 1 8 -12Jul-12 an-13Jul-13 an-14Jul-14 an-15Jul-15 an-16Jul-16 an-17Jul-17 an-18Jul-18 Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jun J a n J J J J J J ▬▬ Employment, lhs ▬▬ Employment_tc, lhs ▬▬ CPI ▬▬ PPI ▬▬ Unemployment, rhs ▬▬ Unemployment_tc, rhs Source: MONSTAT data. Source: MONSTAT data. Public finances remain fragile… …and public debt is set to grow further. Percent of GDP, 2014–18 2014–19, EUR billion 2014–19, percent of GDP 50 1 4 70 0 40 -1 3 -2 65 30 -3 2 20 -4 -5 60 10 -6 1 -7 0 -8 0 55 2014 2015 2016 2017 2018 H1* 2014 2015 2016 2017 2018f 2019f JJ Total revenues and grants JJ Total expenditure and net lending JJ Domestic public debt JJ Foreign public debt ▬▬ Cash deficit, rhs ▬▬ Accrual deficit, rhs JJ Guarantees ▬▬ Public debt, rhs Source: MOF and MONSTAT data. Source: MoF, CBCG and MONSTAT data. Note: 2018 data show central government only. 64  | Montenegro HIGHER BUT FRAGILE GROWTH MONTENEGRO 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) 1.8 3.4 2.9 4.3 3.8 2.8 2.5 Compositioin (percentage points): Consumption 2.6 2.2 4.5 3.1 2.4 2.3 2.9 Investment 0.5 1.9 6.1 5.3 2.7 1.0 0.0 Net exports -1.3 -0.7 -7.6 -4.1 -1.3 -0.5 -0.5 Exports -0.3 2.2 2.4 2.2 2.2 2.3 2.1 Imports (-) 1.0 2.9 10.0 6.3 3.5 2.7 2.6 Consumer price inflation (percent, period average) -0.7 1.5 -0.3 2.4 3.1 2.1 1.6 Public revenues (percent of GDP) 44.6 41.5 42.5 42.0 44.1 43.9 43.0 Public expenditures (percent of GDP) 47.7 48.8 45.6 47.4 46.3 45.6 39.2 Of which: Wage bill (percent of GDP) 13.3 13.1 12.9 12.4 11.7 11.5 11.1 Social benefits (percent of GDP) 14.3 13.3 12.9 12.0 11.3 11.1 11.5 Capital expenditures (percent of GDP) 5.8 9.0 4.3 8.3 8.8 9.6 4.5 Fiscal balance (percent of GDP) -3.1 -7.3 -3.1 -5.4 -2.2 -1.8 3.8 Primary fiscal balance (percent of GDP) -0.9 -4.9 -1.0 -3.0 -0.1 0.4 5.6 Public debt (percent of GDP) 59.9 66.2 64.4 65.1 67.6 66.8 60.6 Public and publicly guaranteed debt 67.1 73.7 71.4 72.5 74.6 73.5 67.0 (percent of GDP) Of which: External (percent of GDP) 47.9 55.7 52.8 54.2 59.2 57.8 51.5 Goods exports (percent of GDP) 10.3 8.9 8.7 9.0 9.5 9.8 10.3 Goods imports (percent of GDP) 50.1 48.9 50.6 52.9 52.9 53.2 53.5 Net services exports (percent of GDP) 20.0 21.6 19.4 20.1 19.8 20.6 21.4 Trade and services balance (percent of GDP) -19.8 -18.5 -22.5 -23.8 -23.6 -22.8 -21.9 Remittance inflows (percent of GDP) 4.3 4.1 3.8 3.8 3.6 3.5 3.3 Current account balance (percent of GDP) -12.4 -11.0 -16.2 -16.3 -16.4 -15.7 -15.1 Foreign direct investment inflows (percent of GDP) 10.2 16.9 9.4 11.4 9.3 8.9 7.6 External debt (percent of GDP) 163.3 162.2 160.9 161.7 163.4 159.9 159.2 Real private credit growth (percent, period average) -1.6 0.0 4.0 4.9 n.a. n.a. n.a. Nonperforming loans 15.9 12.5 10.3 7.3 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 18.0 17.6 17.7 16.1 15.8 15.5 15.0 Youth unemployment rate (percent, period average) 36.3 38.5 36.1 32.0 n.a. n.a. n.a. Labor force participation rate 52.7 53.7 54.5 54.7 n.a. n.a. n.a. (percent, period average) GNP per capita, Atlas (current international $) 15,410 16,050 16,195 16,389 16,586 16,785 16,986 Poverty rate at US$5.5/day, PPP 4.8 4.6 4.2 4.4 4.8 4.6 4.4 (percent of population) Sources: Country authorities, World Bank estimates and projections. Notes: Non-performing loans show year-to-date actuals. Montenegro  |  65 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Serbia yy After sluggish growth in 2017, the economy rebounded in the first half of 2018, bringing projected growth for 2018 to 3.5 percent. yy Responding to faster growth, by the second quarter of 2018 unemployment had fallen to 12.5 percent of the working-age population, down 2.9 percentage points in the second quarter of 2018 compared to the first quarter. yy Both central and general government budgets were in surplus through June, putting them on course to end 2018 with the surplus of 0.6 percent of GDP. yy Though political developments to some extent overshadowed economic reforms, by yearend Serbia is still expected to finish reforms of some of the largest state- owned enterprises and banks. yy The main concerns now are the recent widening of the external deficit and the implications for external debt, a risk that could be exacerbated by potential tightening of the external conditions for emerging markets, slower growth in the EU and accession prospects, as well as regional political dynamic. Recent Economic Developments imports overshadowed the solid 8.2 percent increase in exports. Most of the import increase Economic growth is projected to rise to is explained by machinery and equipment 3.5 percent in 2018, up from an earlier imports, which were up 17 percent through forecast of 3 percent. Growth in the first June as investment recovers. quarter of 4.9 percent year-on-year4 was broad-based, paced by 26.4 percent growth in The labor market continues to improve. construction. Although it is too early to assess Labor Force Survey data suggest that in the first how agriculture will perform for the full year, half of the year about 1 percent more Serbian its production is expected to out-do 2017. As citizens were employed.5 Unemployment for for spending, higher investment was the most the working-age population was 12.5 percent important driver of growth, contributing in the second quarter6; unemployment for all 5 percentage points (pp) in the first half of of 2018 is expected to be about 13 percent. the year. Both public and private investment Low internal mobility has started to create went up. In the first half of 2018 consolidated frictions, for example, with unemployment public capital spending rose by 44 percent in at 15.6 percent in South-East Serbia and nominal terms compared to the first half of 10.2 percent in Vojvodina but with increasingly 2017 (mainly on transport infrastructure). Net pronounced labor shortages in construction exports are expected to subtract 3.2 pp from and other fast-growing sectors in Belgrade. 2018 growth; since 11 percent real growth of Lower unemployment was accompanied by 5 Registered employment was up by about 3.7 percent through June. 4 All percentages are year-on-year unless otherwise stated. 6 Unemployment of workers over 15 years of age fell to 11.9 percent. 66  | Serbia HIGHER BUT FRAGILE GROWTH increase in activity rate which reached a record year earlier—which would still bring down the high 68.5 percent in the second quarter. share of total spending in GDP from 43 percent Average wages went up by 4.2 percent in real in 2017 to 42.7 percent. Consolidated general terms—a progression expected to continue government is projected to close the budget through 2018. year with a surplus of 0.6 percent of GDP, down from 1.2 percent in 2017. The fiscal In the first half of 2018 the budget had surplus, nominal growth of GDP and favorable a surplus of 0.7 percent of annual GDP; a dollar/euro and dinar/euro exchange rates surplus is also projected for the full year. have helped to reduce public debt as a share of Revenues are expected to decline slightly, from GDP from 62.5 percent in 2017 to a projected 44.2 percent of GDP in 2017 to 43.3 percent. 58.4 percent at yearend.8 Nominal revenue collection was strong in the first half, helping to offset higher spending. Appreciation of the dinar helped manage The net result was a surplus of 32.8 billion inflationary pressures. Inflation peaked at dinars—11 billion less than in the first half of 2.6 percent in August 2018, after hitting a 2017. Nominal revenues were up 4.9 percent, low of 1.1 percent in April (partly due to last notably in social insurance contributions (up year’s base effect). The recovery in food and oil by 0.5 percent of annual GDP) and the VAT on prices has pushed up the CPI over the recent imports (up by 0.4 percent of annual GDP).7 months. Due to the low inflationary pressures Collection of the VAT on imported goods and stable inflation outlook, the central bank reflects the increase in imports, and higher (NBS) lowered its policy rate to 3.25 percent social contributions track the growth in formal in March 2018, and to 3 percent in April. employment. Solid growth of revenues is also Between January and August 2018 the dinar projected for the remainder of the year. Thus in had appreciated by 0.2 percent in nominal 2018 total revenues should be about 4 percent terms against the euro. The NBS intervened higher than in 2017. While government regularly in the foreign exchange market to spending is expected to decline in GDP terms smooth excessive short-term exchange rate in 2018, nominal spending on wages, goods volatility. In 2018 the NBS has been a net and services, and capital projects has gone up purchaser of foreign currency, buying a total in the first half of the year. However, in the of €1.6 billion by the end of August. Foreign last few years an active debt management and currency reserves reached €11.4 billion at the stricter control of financial support to utility end of July (equal to 6.5 months of imports), companies and SOEs, have resulted in lower the highest level since March 2013. Net foreign interest payments and activated guarantees, currency reserves9 peaked at €9.5 billion in July. saving about 0.3 percent of GDP more in the first half of 2018 compared to 2017. Credit activity recovered somewhat in Spending for all of 2018 is projected to go up the second quarter, but its structure is by 5.4 percent in nominal terms compared to a 8 Here total public debt includes nonguaranteed debt of local governments. 7 Data for the first half of 2018 show a significant drop in revenues 9 Total foreign currency reserves less foreign-denominated bank from domestic VAT (down by 28 percent compared to the same balances on account of required reserves and liabilities related to period in2017). repayment of IMF loans. Serbia  |  67 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 unfavorable. Sluggish 3.7 percent growth in period of 2017, reaching 5.7 percent of annual total loans by the end of July was mainly driven GDP; for the full year it is expected to reach by more lending to households (up 9.6 percent) 11 percent. The surplus in trade in services and the government (up 4.8 percent). There rose in euro terms by 23.2 percent and in net was a spike in short-term loans (“cash loans”) transfers by 14 percent, thus compensating for to individuals, which at the end of July were the impact of the widening trade deficit on 21.4 percent higher than a year ago (July the CAD, which went down only 1.4 percent. data, in euro terms). As a result, the stock of As for services exports, ICT services went cash loans is now higher than the volume of up a significant 26.2 percent. Remittances mortgages, although the latter are also growing. continued to grow robustly, by 20.2 percent, In July the stock of loans for housing was reaching 3.2 percent of annual GDP. Net FDI 5.8 percent higher than a year ago (in euro increased by 8.6 percent to reach €1.3 billion, terms). On the other hand, business lending on target to reach €2.6 billion for the year. went down by 1 percent in nominal terms, to Chinese investment was part of the higher FDI. a large extent because of a significant write-off Shanding Linglong, which produces car tires, and sale of NPLs (81 and 41 billion dinars, announced a greenfield investment of about respectively, over the previous twelve months) US$1 billion in Zrenjanin Free Zone, to be and partially because loans to SOEs were down completed in three phases through 2025. The 23.3 percent, as those improved performance Chinese Zijin mining company won a tender and due to stricter control by the government for a 65 percent equity stake with a combined over their borrowing. US$550 million in investment for a capital increase and to clear arrears in RTB Bor, the Banking sector performance remains solid. largest Serbian copper and gold producer Gross nonperforming loans (NPLs) again (a debt-ridden pre-bankruptcy SOE). Total edged down, from 9.8 percent in December external debt continues to decline (down 2017 to 6.7 percent at the end of July, as banks €668 million in the first quarter compared to were more aggressive in writing off bad loans or the same quarter of 2017) despite an increase sold them to specialized investors. More than in the CAD and despite the increase in cross- 70 percent of all NPLs are with businesses (their border loans (up by €29 million in the first value is about €1 billion, of which 300 million quarter compared to the same quarter of 2017). is owed by enterprises now in bankruptcy proceedings). The value of household NPLs is about €400 million. The number of NPLs is Outlook and Risks expected to continue down over the medium term, although probably at not as fast as in the Growth of the Serbian economy over the previous 18 months. medium term is expected to be a healthy 4 percent or so. Growth in 2018 is likely to Although the trade deficit continues to be faster than currently projected, and the widen, in the first half of 2018 the current momentum should continue into the medium account deficit (CAD) was generally term with investment and exports as the main unchanged in euro terms. The trade deficit drivers. Exports are projected to grow by went up by 26.5 percent, compared to the same about 9.5 percent annually in real terms; and 68  | Serbia HIGHER BUT FRAGILE GROWTH investment should rise by about 6.5 percent addition, the uncertainty created by regional each year for the next three years. Announced political developments, the potential tightening increases in public wages and expected increases of financing conditions for emerging markets in employment and wages generally will also in general, as well as concerns about the speed drive up consumption. It is not yet clear how of EU growth, is making both local and foreign much of this will spill over to imports, however, investors more cautious. This in turn delays and worsen external imbalances. completion of some important projects related to both infrastructure and the real sector. The medium-term growth projections crucially depend on the pace of structural reforms and progress with EU accession. It is vital that Serbia deals with its unsustainable SOEs. Recent efforts to resolve some of the main loss-makers are encouraging. Privatization of state-owned financial institutions should be accelerated. Meanwhile, expected fast growth in the EU, Serbia’s main trading partner and investor, is favorable. Speeding up the EU accession process is important because it will both strengthen institutions and send a positive signal to investors. In addition, the work on regional projects, mainly dealing with connective infrastructure like roads and railways, would help Serbian exporters and stimulate growth of the economy in general. The downside risks are mainly political. Although Serbia’s growth of 4.9 percent in the first half of 2018 is aligned with the results of other Central European countries,10 the constant threat of early elections; the recent resignation of the Minister of Finance; work on resolving relations with Kosovo; slower than planned opening of chapters of the acquis for EU accession; a gap in formal IMF engagement; and some deterioration in the country’s governance and rule of law indicators—all suggest that growth could have been faster. In 10 Based on preliminary estimates for Q2, the simple average for growth in this group (Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Slovakia, and Slovenia) was about 4 percent. Serbia  |  69 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 Growth in H1 2018 was broad-based. The performance of the labor market improved. Contribution to GDP growth in percentage points Percent 9 50 7 40 5 3 30 1 20 -1 10 -3 -5 0 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 15 15 15 15 16 16 16 16 17 17 17 17 18 18 Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q1- Q2- 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 JJ Consumption, final JJ Investment JJ Net exports ▬▬ GDP, real growth JJ Employment rate JJ Unemployment rate Source: Statistics Office of Serbia. Source: Statistics Office of Serbia. Credit activity recovered, mainly because loans Cash loans may be increasing too fast. to households increased. € million Stock of loans in € million 12,000 3,500 10,000 3,000 8,000 2,500 2,000 6,000 1,500 4,000 1,000 2,000 500 0 0 -06 -07 -08 -09 -10 -11 -12 -13 -14 -15 -16 -17 -18 -15 Jul- 15 -16 Jul- 16 -17 Jul- 17 -18 Jul- 18 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan ▬▬ Private enterprises ▬▬ Government ▬▬ Households ▬▬ SOEs Source: National Bank of Serbia. Source: Ministry of Finance; World Bank staff calculations. The trade deficit widens, but the CAD is under High FDI is helping push up reserves. control. 12-month cumulative, percent of GDP Percent 0 11,500 800 -2 11,000 700 -4 600 -6 10,500 -8 10,000 500 -10 400 -12 9,500 300 -14 9,000 200 -16 8,500 -18 100 -20 8,000 0 -11 -12 -13 -14 -15 -16 -17 -18 Q2 7 Q3 7 Q4 7 Q1 7 Q2 5 Q3 5 Q2 6 Q3 6 Q4 6 Q1 6 Q2 8 8 Q4 5 Q1 5 Jan Jan Jan Jan Jan Jan Jan Jan -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 Q1 ▬▬ Trade balance ▬▬ CAD ▬▬ Direct investment, net, rhs ▬▬ Reserves, lhs Source: National Bank of Serbia. Source: National Bank of Serbia. 70  | Serbia HIGHER BUT FRAGILE GROWTH SERBIA 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) -1.8 0.8 2.8 1.9 3.5 3.5 4.0 Composition (percentage points): Consumption -1.1 0.1 1.1 1.5 2.7 2.6 3.6 Investment 0.0 1.6 1.5 2.3 1.7 1.7 1.4 Net exports -0.7 -0.9 0.2 -1.9 -1.0 -0.8 -1.0 Exports 2.3 4.5 5.8 5.2 5.9 5.5 5.6 Imports (-) 3.0 5.4 5.6 7.1 6.8 6.3 6.5 Consumer price inflation (percent, period average) 2.1 1.4 1.1 3.2 1.6 2.6 3.0 Public revenues (percent of GDP) 41.5 41.9 43.2 44.2 43.3 42.2 42.0 Public expenditures (percent of GDP) 48.1 45.6 44.5 43.0 42.7 42.7 42.5 Of which: Wage bill (percent of GDP) 11.7 10.4 9.8 9.5 9.9 9.7 9.7 Social benefits (percent of GDP) 17.8 17.6 16.7 16.1 15.7 15.6 15.5 Capital expenditures (percent of GDP) 2.5 2.8 3.3 3.0 3.3 3.6 3.6 Fiscal balance (percent of GDP) -6.6 -3.7 -1.3 1.2 0.6 -0.5 -0.5 Primary fiscal balance (percent of GDP) -3.7 -0.5 1.8 3.9 2.8 1.8 1.9 Public debt (percent of GDP) 64.2 68.8 67.8 57.7 53.8 51.3 49.0 Public and publicly guaranteed debt 71.9 75.9 73.0 62.5 58.4 55.8 53.0 (percent of GDP) Of which: External (percent of GDP) 41.5 45.2 45.9 38.0 37.0 37.0 36.0 Goods exports (percent of GDP) 31.9 33.9 37.0 38.3 39.7 41.3 42.5 Goods imports (percent of GDP) 44.3 45.8 46.0 49.1 50.7 51.8 53.0 Net services exports (percent of GDP) 1.4 2.2 2.6 2.6 2.7 2.8 2.6 Trade balance (percent of GDP) -10.9 -9.8 -6.4 -8.2 -8.2 -7.7 -7.9 Remittance inflows (percent of GDP) 5.8 6.4 5.6 5.8 5.7 5.5 5.5 Current account balance (percent of GDP) -6.0 -3.7 -3.1 -5.7 -5.7 -5.5 -5.3 Foreign direct investment inflows (percent of GDP) 3.7 5.4 5.5 6.6 6.5 5.9 5.7 External debt (percent of GDP) 77.1 78.3 76.5 72.0 65.2 61.0 56.7 Real private credit growth (percent, period average) -3.8 -1.2 5.0 1.9 n.a. n.a. n.a. Non-performing loans 21.5 21.6 17.0 9.8 n.a. n.a. n.a. (percent of gross loans, end of period) Unemployment rate (percent, period average) 19.2 17.7 15.3 13.5 13.0 12.5 11.5 Youth unemployment rate (percent, period average) 47.0 42.9 35.0 32.0 n.a. n.a. n.a. Labor force participation rate 51.9 51.6 53.3 54.0 n.a. n.a. n.a. (percent, period average) GDP per capita, PPP (current international $) 13,398 13,454 13,773 15,000 15,942 16,925 18,020 Poverty rate at US$5.5/day, PPP 24.1 24.0 23.1 22.4 21.7 20.9 19.7 (percent of population) Sources: Country authorities, World Bank estimates and projections. Notes: Non-performing loans show year-to-date actuals. Serbia  |  71 Key Economic Indicators HIGHER BUT FRAGILE GROWTH 2014 2015 2016 2017 2018e 2019f 2020f Real GDP growth (percent) Albania 1.8 2.2 3.4 3.8 4.0 3.6 3.5 Bosnia and Herzegovina 1.1 3.0 3.1 3.0 3.2 3.4 3.9 Kosovo 1.2 4.1 4.1 3.7 4.0 4.5 4.5 Macedonia, FYR 3.6 3.9 2.9 0.0 2.5 2.9 3.2 Montenegro 1.8 3.4 2.9 4.3 3.8 2.8 2.5 Serbia -1.8 0.8 2.8 1.9 3.5 3.5 4.0 WB6 0.3 2.2 3.1 2.4 3.5 3.5 3.8 Consumer price inflation (percent, period average) Albania 1.6 1.9 1.3 2.0 2.1 2.5 2.9 Bosnia and Herzegovina -0.9 -1.0 -1.6 0.8 1.1 1.4 1.4 Kosovo 0.4 -0.5 0.3 1.5 0.7 1.5 1.6 Macedonia, FYR -0.2 -0.3 -0.2 1.3 1.6 2.0 2.0 Montenegro -0.7 1.5 -0.3 2.4 3.1 2.1 1.6 Serbia 2.1 1.4 1.1 3.2 1.6 2.6 3.0 WB6 1.0 0.7 0.4 2.2 1.6 2.2 2.4 Public expenditures (percent of GDP) Albania 32.3 31.5 29.4 29.7 30.0 29.9 29.5 Bosnia and Herzegovina 46.2 42.5 42.1 41.4 45.0 42.6 41.5 Kosovo 26.6 27.1 27.7 28.2 29.9 30.2 31.2 Macedonia, FYR 33.9 34.4 33.0 33.7 34.6 35.3 35.4 Montenegro 47.7 48.8 45.6 47.4 46.3 45.6 39.2 Serbia 48.1 45.6 44.5 43.0 42.7 42.7 42.5 WB6 39.1 38.3 37.0 37.2 38.1 37.7 36.6 Public revenues (percent of GDP) Albania 26.3 26.6 27.6 27.7 28.0 28.2 28.3 Bosnia and Herzegovina 44.2 43.2 43.1 43.7 44.5 42.9 42.7 Kosovo 24.0 25.1 26.3 27.0 27.5 27.4 27.7 Macedonia, FYR 29.7 31.0 30.3 30.9 32.0 32.7 32.8 Montenegro 44.6 41.5 42.5 42.0 44.1 43.9 43.0 Serbia 41.5 41.9 43.2 44.2 43.3 42.2 42.0 WB6 35.0 34.9 35.5 35.9 36.6 36.2 36.1 Source: World Bank calculations and projections using data from national authorities and World Economic Outlook (2017). Key Economic Indicators  |  75 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.14 2014 2015 2016 2017 2018e 2019f 2020f Fiscal balance (percent of GDP) Albania -6.0 -4.9 -1.8 -2.0 -2.0 -1.7 -1.2 Bosnia and Herzegovina -2.1 0.7 1.0 2.4 -0.5 0.3 1.2 Kosovo -2.6 -2.0 -1.4 -1.2 -2.4 -2.9 -3.5 Macedonia, FYR -4.2 -3.4 -2.7 -2.8 -2.6 -2.6 -2.6 Montenegro -3.1 -7.3 -3.1 -5.4 -2.2 -1.8 3.8 Serbia -6.6 -3.7 -1.3 1.2 0.6 -0.5 -0.5 WB6 -4.1 -3.4 -1.5 -1.3 -1.5 -1.5 -0.5 Public debt (percent of GDP) Albania 66.1 69.1 68.7 67.8 65.5 62.7 61.7 Bosnia and Herzegovina 42.0 41.9 42.4 36.1 35.1 34.0 33.2 Kosovo 10.4 12.7 14.1 15.9 17.2 18.6 20.1 Macedonia, FYR 38.1 38.1 39.6 39.3 42.4 43.5 44.2 Montenegro 59.9 66.2 64.4 65.1 67.6 66.8 60.6 Serbia 64.2 68.8 67.8 57.7 53.8 51.3 49.0 WB6 46.8 49.5 49.5 47.0 46.9 46.1 44.8 Public and publicly guaranteed debt (percent of GDP) Albania 72.0 72.7 72.3 71.6 69.5 67.2 64.8 Bosnia and Herzegovina 43.1 43.2 43.3 38.0 36.7 35.6 34.8 Kosovo 10.6 12.8 14.4 16.6 18.0 19.3 20.8 Macedonia, FYR 45.7 46.6 48.4 47.6 50.6 55.7 58.3 Montenegro 67.1 73.7 71.4 72.5 74.6 73.5 67.0 Serbia 71.9 75.9 73.0 62.5 58.4 55.8 53.0 WB6 51.7 54.2 53.8 51.5 51.3 51.2 49.8 Goods exports (percent of GDP) Albania 9.3 6.8 6.0 6.7 6.3 6.4 6.5 Bosnia and Herzegovina 25.1 25.2 25.7 28.5 31.2 33.9 35.2 Kosovo 5.8 5.6 5.1 6.0 5.6 5.6 5.7 Macedonia, FYR 32.5 33.6 35.7 40.4 42.7 44.6 46.3 Montenegro 10.3 8.9 8.7 9.0 9.5 9.8 10.3 Serbia 31.9 33.9 37.0 38.3 39.7 41.3 42.5 WB6 24.7 25.1 26.7 28.5 29.8 31.2 32.2 Source: World Bank calculations and projections using data from national authorities and World Economic Outlook (2017). 76  | Key Economic Indicators HIGHER BUT FRAGILE GROWTH 2014 2015 2016 2017 2018e 2019f 2020f Trade balance (percent of GDP) Albania -19.1 -17.3 -16.8 -15.1 -14.8 -14.2 -13.7 Bosnia and Herzegovina -22.7 -18.8 -17.1 -16.7 -16.7 -17.0 -17.2 Kosovo -28.7 -28.5 -27.2 -26.4 -27.6 -27.4 -26.8 Macedonia, FYR -17.2 -16.2 -15.0 -13.9 -13.3 -13.1 -12.5 Montenegro -19.8 -18.5 -22.5 -23.8 -23.6 -22.8 -21.9 Serbia -10.9 -9.8 -6.4 -8.2 -8.2 -7.7 -7.9 WB6 -16.7 -15.1 -13.2 -13.6 -13.5 -13.1 -13.0 Current account balance (percent of GDP) Albania -10.8 -7.8 -6.8 -6.9 -6.8 -6.6 -6.1 Bosnia and Herzegovina -7.4 -5.7 -5.1 -4.8 -5.3 -5.5 -5.6 Kosovo -6.9 -8.6 -7.9 -6.6 -6.9 -8.5 -9.0 Macedonia, FYR -0.5 -2.0 -2.7 -1.3 -1.2 -1.4 -1.5 Montenegro -12.4 -11.0 -16.2 -16.3 -16.4 -15.7 -15.1 Serbia -6.0 -3.7 -3.1 -5.7 -5.7 -5.5 -5.3 WB6 -6.6 -5.1 -4.9 -5.7 -5.8 -5.8 -5.7 External debt (percent of GDP) Albania 69.6 73.6 73.6 73.6 73.6 73.6 73.6 Bosnia and Herzegovina 77.1 72.2 71.0 70.3 69.3 68.8 68.8 Kosovo 31.2 33.3 32.7 33.4 34.4 34.6 35.2 Macedonia, FYR 69.6 68.5 72.0 72.7 77.4 78.2 78.9 Montenegro 163.3 162.2 160.9 161.7 163.4 159.9 159.2 Serbia 77.1 78.3 76.5 72.0 65.2 61.0 56.7 WB6 81.3 81.4 80.9 80.1 80.5 78.8 77.9 Unemployment rate (period average, percent) Albania 17.5 17.1 15.2 13.8 n.a. n.a. n.a. Bosnia and Herzegovina 27.5 27.7 25.4 20.5 18.4 n.a. n.a. Kosovo 35.3 32.9 27.5 30.4 n.a. n.a. n.a. Macedonia, FYR 28.0 26.1 23.7 22.4 20.4 19.4 18.0 Montenegro 18.0 17.6 17.7 16.1 15.8 15.5 15.0 Serbia 19.2 17.7 15.3 13.5 13.0 12.5 11.5 WB6 24.3 23.2 20.8 19.4 16.9 15.8 14.8 Source: World Bank calculations and projections using data from national authorities and World Economic Outlook (2017). Key Economic Indicators  |  77 Western Balkans Regular Economic Report No.14 | Fall 2018 View this report online: www.worldbank.org/eca/wbrer Title of Painting by Rikardo Druskic Rikardo Druskic is a 28-year-old artist from Bosnia and Herzegovina who has to date created about 600 works of art. His work has been exhibited not only in his home country, but also internationally, including in New York, Miami, and Los Angeles. In November 2017, he had his first solo international exhibit, “Digginside”, in Berlin. Twenty of his artworks are currently on view in the Los Angeles Center for Digital Arts (LACD). People forge ideas, people mold dreams, and people create art. To connect local artists to a broader audience, the cover of this report and following editions will feature art from the Western Balkan countries.