POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise JANUARY J E 2 1 • Number 2013 Numb 103 18 74852 South East Europe Six: From Double-Dip Recession to Accelerated Reforms South East Europe Regular Economic Report Team This note discusses the external environment, economic outlook, and key policy challenges for the six South East Euro- pean Countries (SEE6)—Albania, Bosnia and Herzegovina (BIH), Kosovo, the former Yugoslav Republic (FYR) of Macedonia, Montenegro, and Serbia—as they seek to reignite economic recovery. After two years of fragile recovery from the global recession, as a group, SEE6 countries experienced a double-dip recession in 2012. Deteriorating external conditions, the impact of the severe winter on economic activity, and a continuing rise in unemployment early in the year took a toll on consumption, investments, and exports. The rise in unemployment continues to threaten the social fabric. Credit recovery and fiscal consolidation are under threat. Nonperforming loans (NPLs)—thought to be stabilizing only a few months ago—are again on the rise. As a result, both within and outside the region, the environment has become much more difficult to navigate, and the policy trade-offs necessary to stabilize economies and reignite growth have become more difficult to make. To overcome these challenges, SEE6 countries need more intensive policy reform to reduce public debt and accelerate structural reforms, especially in fiscal consolidation and the financial sector, labor markets, and business environment. Additional external financing from international financial institutions (IFIs) for growth and jobs could prove effective, but only if accompanied by intensified fiscal and structural reforms. External Environment ing global uncertainty; and the risk of an uncontrolled unwinding of China’s high investment rates. To further com- After months of decelerating economic activity following tur- plicate the situation, low stocks of maize and wheat could re- bulence in financial markets in the second quarter of 2012, sult in even higher food prices, with serious consequences for global economic activity is slowly picking up once again—most the poor. notably in developing countries. But the modest rebound is These global and eurozone developments are adversely tenuous. The latest data show declining growth in industrial production in the world’s two largest economies, the United affecting the SEE6 countries, primarily through foreign trade, States and Japan. Due to mid-year weakness, calendar year financing, and remittance channels. After growing by about 2 global gross domestic product (GDP) growth projections are percent annually in 2010–11, the combined real GDP of being tentatively downgraded by about 0.2 percentage points SEE6 will shrink—to 0.6 percent in 2012, with real output in to 2.3 percent in 2012, and by 0.6 percentage points in 2013 Serbia declining by as much as 2 percent. With weak econom- to 2.4 percent, mainly because of the recession in the euro- ic activity, the unemployment rate in SEE6 countries, already zone (figure 1). Threats to the recovery include the difficul- among the highest in the world, keeps rising (figure 2). Also, ties of implementing eurozone fiscal consolidation; remain- it is now clear that even in the best of circumstances, the road 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 1. External Environment: Clouds on the Horizon make a dent in high unemployment, which might continue to rise. 10 projections were downgraded in both 2012 and 2013 After two years of deep crisis, a 8 sluggish recovery, rising unemploy- developing ment and poverty, and a continuing 6 recession—even with the best efforts on fiscal consolidation and structural GDP growth (%) 4 reforms, which must continue—there is a danger that SEE6 countries have 2 been caught in a vicious circle that 0 reinforces the cycle of long-term aus- terity, low if not negative growth, -2 high debt, and even higher risks of revised forecast social upheaval. In this difficult envi- world -4 ronment, SEE6 countries are facing high income tough policy challenges in order to -6 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 maintain stability while promoting Source: Global Economic Prospects 2012. recovery. Figure 2. Double-Dip Recession, Rising Unemployment Fiscal and Structural Challenges 7 25 SEE6 GDP growth (left) SEE6 unemployment Some of the obstacles that SEE6 countries must ad- 6 rate (right) 24 dress are major fiscal and structural challenges. In 5 percentage of labor force the fiscal area, Serbia, Albania, and Montenegro in percentage points 4 23 particular will need to persevere in their efforts to 3 22 reduce fiscal deficits and public debt, even as they 2 must continue to improve their investment climates 1 21 and reform labor markets and their public sectors 0 20 (figure 3). Also, in all SEE6 countries, public sector -1 arrears pose special challenges for fiscal manage- 19 -2 ment and the private sector, and there are unfin- -3 2007 2008 2009 2010 2011 2012 18 ished structural reforms agendas. Source: Bogetic and others 2012. On the financial sector front, the good news is that through a combination of early reforms, the re- gion avoided meltdowns during the global crisis, although a to sustained recovery will be arduous and the risks may be for- large agenda remains. While the impact of the eurozone crisis midable. Among the main clouds on the horizon for 2013 are the uncertain recovery of the eurozone and high commodity prices—risks to which all the SEE6 countries are highly vul- Table 1. SEE6 Growth Outlook for 2012–13 (in percent) nerable. Also worrisome for SEE6 households is the risk of a 2012 2013 new food price shock, which could exacerbate poverty and   2011 (estimate) (projection) put pressure on the middle class. Albania 3.0 0.8 1.6 The SEE6 region as a whole remained in a recession dur- BIH 1.3 0.0 0.5 ing 2012, with growth in 2013 expected to be sluggish at Kosovo 5.0 3.6 3.3 1.6 percent (table 1). Growth is expected to recover because of a bounce back in agriculture, increasing auto exports Macedonia, FYR 2.8 0.0 1.0 from Serbia, and some easing of external and domestic de- Montenegro 3.2 0.2 0.8 mand conditions. Growth in 2013 is projected to be lowest Serbia 1.6 –2.0 2.0 in BIH (0.5 percent), and fastest in Kosovo (3.3 percent). SEE6 2.2 –0.6 1.6 Serbia’s economic growth is expected to reach about 2 per- EU-11 3.1 0.9 1.3 cent in 2013, driven mainly by accelerated exports and the Euro area 1.5 –0.4 -0.1 value chain from the large Fiat factory and by a cyclical agri- cultural bounce back. But growth will not be enough to Source: World Bank, for EU-15, European Commission. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 3. Public Debt in SEE6 Countries (percent of GDP) Figure 4. Credit Growth (% change, Q-on-Q) 70 9 Albania 0.8 60 guarantees domestic Bosnia and 6 50 external Herzegovina 0.5 40 5 Kosovo -1.0 30 5 Macedonia, FYR -2.2 20 21 10 Montenegro -3.4 Q3–2007 0 Serbia 7 2.0 Q3–2012 o a ia o YR vin d gr ni ov rb go n ne ba a ze a ,F s Se Ko er ia te Al ia Source: IFS. H osn on on M ed B ac M Source: Bogetic and others 2012. Figure 5. NPLs (% of Total Loans) and Provisioning (% of NPLs, 2012 Q3) has been contained to date, SEE6 banking systems are still 140 characterized by rising or already high NPLs, low credit Serbia 120 growth, eroding capital, and minimal profitability. High lev- Kosovo Macedonia, FYR els of NPLs mean that loan quality has deteriorated, and provisions to NPLs 100 banks have chronic difficulties in writing off NPLs because Bosnia and Herzegovina 80 ineffective insolvency regimes generally preclude rapid reso- lution of problem loans. The recent rise in NPLs has also lim- Albania 60 ited the appetite as well as the ability of banks to resume lend- ing. Moreover, bank loan-to-deposit ratios remain above 100 40 percent in BIH and Serbia, reflecting a small domestic deposit Montenegro 20 base and relatively high dependence on wholesale funding (figures 4 and 5). 0 In the area of labor markets, high unemployment is a ma- 0 5 10 15 20 25 jor economic and social challenge for the region (figure 6). NPLs to total loans Source: IMF and central banks. Kosovo, with unemployment at 43.5 percent, FYR Macedo- nia’s unemployment at 31 percent, and BIH’s and Serbia’s Figure 6. Unemployment Rates in SEE6 Countries unemployment at about 28 percent, are outliers in Europe as 50 a whole and also rank high globally. According to the World 45 Bank’s World Development Indicators, few countries in the world have unemployment rates higher than 25 percent. As 40 mentioned in previous issues of this report (Bogetic and oth- 35 ers 2012), youth and long-term unemployment are particu- 30 larly daunting problems for SEE6 countries. A prolonged eco- 25 nomic downturn would add to the already persistent problem 20 of long-term unemployment. 15 Are labor regulations to blame for the poor perfor- 10 mance of SEE6 labor markets? The answer seems to be par- 5 tially yes, although broader issues related to the structure of 0 economic growth and competitiveness gaps also contribute 2007 2008 2009 2010 2011 to SEE6 poor labor market performance. In countries where Albania Bosnia and Kosovo the majority of jobs are created by the private sector, labor Herzegovina regulations can facilitate or impede job creation and wage Macedonia, FYR Montenegro Serbia earnings. Labor markets need to be regulated to protect EU-10 workers from unfair treatment and ensure efficient con- Source: Bogetic and others 2012. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 7. The World Economic Forum Labor Efficiency Index, 2012–13 6 120 global rank 5 100 4 80 3 60 2 40 1 20 0 0 Albania Montenegro FYR Bosnia and Serbia Macedonia Herzegovina cooperation in labor-employer relations flexibility of wage determination hiring and �ring practices Source: World Economic Forum. tracting between employers and workers. Excessive regula- show a similar picture. The average ranking of SEE6 countries tions, however, may go beyond addressing market distor- lags significantly behind that of the EU-11, highlighting long, tions and constrain job creation. So where are the SEE6 unfinished agendas. countries on the regulatory spectrum? One indication is The unfinished agenda in the business environment of provided by the World Economic Forum’s (WEF) Global SEE6 countries corresponds to their areas of weak perfor- Competitiveness Index, which captures labor market regu- mance on the Doing Business scale (figure 8). Interestingly, lation. The labor efficiency index, one of 11 subindexes, as- those weak areas—largely common to all SEE6 countries—re- sesses the efficiency and flexibility of the labor market. It late to business regulations governing property transactions, consists of four areas, three of which collect perceptions, the housing and construction industry, and enforcement of while the fourth—on redundancy costs—covers labor legisla- contracts. But FYR Macedonia has managed to improve many tion. Clearly, SEE6 countries (except for Kosovo, which is dimensions of its business environment, showing that it can not covered) rank relatively low on regulatory efficiency (fig- be done in other countries in the region too. Also, some SEE6 ure 7). Albania, 68th out of 144 countries, ranks highest; countries fare relatively well in terms of ease of paying taxes. the other four all rank between 93rd and 100th. Among But it is important to stress that while these indicators cap- neighboring countries, Bulgaria is ranked 45th, Croatia ture certain aspects of the regulatory and legal environment, 106th and Romania 124th. Excluding Albania, the other there are other aspects of investment climate and business four SEE6 countries score lowest on cooperation in labor- practices that can be important for investment and growth, employer relations, followed by hiring and firing practices. for example, quality of infrastructure and inequities in the Finally, business environment indicators have shown im- tax treatment of formal and informal firms, which can be sig- provement in SEE6 countries, especially in areas such as start- nificant impediments to domestic and foreign investment. ing a business, dealing with construction permits, and ease of SEE6 countries should interchange best practices in legal and paying taxes. However, the rankings of the six countries based regulatory environment as well as other aspects of the invest- on the Doing Business indicators range widely and much ment climate so that ranking improvements can be compre- work clearly still needs to be done for these countries to be- hensive and faster. This is important not only to attract for- come more attractive destinations for domestic and foreign eign investors, but also to serve as a benchmark for reforms investments. Country-specific investment climate surveys and promote growth. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 8. SEE6: Weak Areas in the Business Environment, 2012 a. Dealing with construction permits b. Registering property 200 150 150 100 100 50 50 0 0 a o ia o go nd R ni gr ov rb FY a ba ze a ne vin s Se a Ko o ia YR vo er ia go nd , Al ni te gr ia rb H sn a so ba ,F on ze a on ne vin Se Bo Ko er ia Al M ia ed te H sn on on ac Bo ed M M ac Europe and Central Asia average for M dealing with construction permits ECA average on registering property c. Enforcing contracts d. Paying taxes 150 200 150 100 100 50 50 0 0 o ia YR vo a go nd gr a o ia vo go nd ni YR rb ni a so gr ne rb ,F ze a a ba so vin Se ba ze a ne vin ,F Ko Se er ia te ia Ko Al er ia Al H osn te ia on on H sn on on M ed Bo B M ed ac ac M M Europe and Central Asia Europe and Central Asia average on enforcing contracts average on paying taxes Source: Doing Business Indicators 2013. The Path Forward: Accelerating Reforms tral and South East European countries over the next two and Mobilizing Financing years. In SEE6 countries, this timely initiative would likely be Given the fiscal and structural challenges, what is now need- delivered via the Western Balkans Investment Framework ed is more intensive policy reform in SEE6 countries to re- (WBIF) and other IFI resources. European Instrument for duce public debt and accelerate structural reforms, especially Pre-Accession Assistance (IPA) resources will also be impor- in the fiscal and financial sectors, labor markets, and invest- tant, especially in supporting institutional reform and rural ment climate. If such accelerated reforms materialize, exter- development. By focusing on major infrastructure of regional nal support—well coordinated and targeting the region as a significance (rail, highways, energy, and gas) and on jobs and whole, not just individual countries—from the European small and medium enterprises, the efficiency of investments, Union and global IFIs could help ease the transition to more growth, and employment could be substantially heightened. sustained growth in the medium term. However, additional financing for growth and jobs might In November 2012, the European Investment Bank, the prove effective only if accompanied by intensified fiscal and European Bank for Reconstruction and Development, and structural reforms, especially in the areas of investment cli- the World Bank announced €30 billion in financing for Cen- mate, labor markets, and governance. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise About the Authors on energy infrastructure, and Javier Suarez on lessons of privatizations. This note was authored by a team led by Željko Bogetić, Lead Economist and Country Sector Coordinator for Western Bal- Note kans Unit at the the World Bank, and includes the follow- 1. This note is drawn on Bogetic and others (2012). ing team members: Dilek Aykut, Alexandru Cojocaru, Damir Ćosić, Simon Davies, Mike Edwards, Agim Demukaj, Reference Borko Handjiski, Caterina Ruggeri Laderchi, Erjon Luci, San- Bogetić, Zeljko, Dilek Aykut, Damir Cosic, and others. 2012. ja Madzarević-Sujster, Lazar Sestović, Bojan Shimbov, and “South East Europe Regular Economic Report No. 3: From Kenneth Simler. Carolina Sanchez-Paramo and Indhira Van- Double-Dip Recession to Accelerated Reform.� World Bank essa Santos provided inputs on labor markets, Arturo Rivera Policy Research Working Paper No. 3, Washington, DC. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 6 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise