WESTERN BALKANS REGULAR ECONOMIC REPORT Toward Sustainable Growth No. 24  |  Fall 2023 Western Balkans Regular Economic Report No.24 | Fall 2023 Toward Sustainable Growth © 2023 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. The cutoff date for the data used in this report was September 28, 2023. TOWARD SUSTAINABLE GROWTH Acknowledgements This Regular Economic Report (RER) covers economic developments, prospects, and economic policies in the Western Balkans region: Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia. The report is produced twice a year by a team led by Natasha Rovo, Richard Record, and Christos Kostopoulos (Task Team Leaders). This issue’s core team included World Bank staff working on the Western Balkan countries (with additional contributions to specific sections): Natasha Rovo, Richard Record (Growth section), Sanja Madžarević-Šujster, Joana Madjoska (Labor section), Leonardo Ramiro Lucchetti, Alexandru Cojocaru, Carlos Gustavo Ospino Hernandez, Anna Fruttero, Zurab Sajaia (Poverty section), Milan Lakićević, Besart Myderrizi (Fiscal section), Hilda Shijaku, Isolina Rossi, Tim Pionteck (Monetary section), Alper Oguz, Jane Hwang, Holti Banka, Matija Laco (Financial sector section), Sandra Hlivnjak, Tihomir Stučka (External section), Christos Kostopoulos, Lazar Šestović, Marie Albert, Sergiy Kasyanenko, Hrisyana Stefanova Doytchinova (Outlook section), Sergiy Zorya, Fang Zhang, Demetris Psaltopoulos, Goran Zhivkov (Spotlight). Research assistance was provided by Suzana Jukić. Peter Milne provided assistance in editing, and Budy Wirasmo assistance in typesetting. The cover image was created by Sanja Tanić. The dissemination of the report and external and media relations are managed by an External Communications team comprised of Filip Kochan, Sanja Tanić, Lundrim Aliu, Anita Božinovska, Ana Gjokutaj, Jasmina Hadžić, Gordana Filipovic, and Mirjana Popović. The team is grateful to Xiaoqing Yu (Regional Director for the Western Balkans); Asad Alam (Regional Director, Equitable Growth, Finance and Institutions); Jasmin Chakeri (Practice Manager, Macroeconomics, Trade, and Investment Global Practice); Frauke Jungbluth (Practice Manager, Agriculture & Food 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/. iii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Contents Acknowledgementsiii Abbreviationsviii Toward Sustainable Growth 1 1. Overview 2 2. Recovery and convergence are occurring at different speeds across the Western Balkans 6 3. The labor market remained strong against all odds, but cooling is underway in some countries10 4. Low labor force participation, coupled with significant gender gaps, constrains further poverty reduction 15 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation 19 6. Inflation is easing, but price pressures persist 24 7. The financial sector remains stable while the outlook is fragile 30 8. Despite elevated merchandise trade deficits, external current accounts are set to improve36 9. Reforms are needed to consolidate the recovery and move toward sustainable growth 39 10. Spotlight: Greening Agriculture in the Western Balkans 44 Country Notes 64 Albania65 Bosnia and Herzegovina 70 Kosovo76 Montenegro83 North Macedonia 88 Serbia94 Key Economic Indicators 99 iv Contents TOWARD SUSTAINABLE GROWTH Figures Real GDP growth in 2022 was stronger than expected, but decelerated over the Figure 2.1.  course of 2022 and in 2023… 6  as weakening global demand has a diverse impact across the WB6, due to Figure 2.2. … their different economic structures 6 Figure 2.3. Industrial production continues decelerating… 7 Figure 2.4. …as exports are highly concentrated toward advanced economies in ECA 7 Figure 2.5. Consumption remains an important growth driver, despite rising price pressures 8 Figure 2.6. Some countries display more growth volatility than others 8  e Western Balkans’ standards of living are between one-quarter and one-half Figure 2.7. Th that of the EU average, but convergence is moving at different speeds 9 Figure 3.1. The employment rate reached a historical high in the Western Balkans… 10 Figure 3.2. …but a slowdown is underway in most countries 10 Figure 3.3. Services and construction had the highest job creation rates 11 Businesses require policies to retain the labor force and attract diaspora to the Figure 3.4.  Western Balkans labor market 11 Figure 3.5. Unemployment rate declined to a new low 12 Figure 3.6. Inactivity declined in most countries as labor market strengthened 12 Figure 3.7. Youth unemployment rate declined to a new low 13  ore women returned to the labor market than men in 2023, except in Kosovo Figure 3.8. M and North Macedonia 13 Gross minimum wages increased twice as fast compared with EU peers over the Figure 3.9.  past two years 14 Figure 3.10. Labor and other costs increased over the last year 14 Figure 4.1. Poverty is projected to continue to fall in the region, but at a slower pace 15 Figure 4.2. Male and female labor force participation (15+) and GDP per capita, latest data 16 Significant differences between male and female labor force participation pose a Figure 4.3.  major challenge 17 Figure 4.4. Share of regular full-time working hours children spend in public school 18 Montenegro, Albania, and Serbia set to experience an improvement in fiscal Figure 5.1.  balances…19 …but consolidation is driven by contained expenditures only in Serbia and Figure 5.2.  Montenegro  19 Figure 5.3. The share of social benefit remains high… 20 Figure 5.4. …while all WB6 countries have turned to higher spending on public wages 20 Figure 5.5. PPG debt is declining in all countries except North Macedonia… 21 Figure 5.6. …and the trend is similar for external debt 21 Figure 6.1. Inflation is decelerating, but price pressures remain elevated 24 Figure 6.2. Domestic food price inflation remains high around the world 24 Figure 6.3. After peaking in 2022, inflation in the WB6 has been on a downward trend… 25 Contents v WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 6.4. …supported by easing commodity prices 25 Policy rates increased reflecting persistent inflation, but real policy rates remain Figure 6.5.  negative26 Exchange rates were stable in North Macedonia and Serbia but appreciated in Figure 6.6.  Albania26 Figure 6.7. Drivers of inflation (GDP deflator income approach) 29 Figure 7.1. Credit growth was slashed by half compared with a year ago 30 Corporate loans experienced a sharp slowdown and even shrunk in Albania, BiH Figure 7.2.  and Serbia 30 Figure 7.3. NPLs continued a downward trend 31 Gap between Stage 3 and 2 loans is increasing, an indication of forward-looking Figure 7.4.  recognition of potential loan impairment 31 Figure 7.5. Banks’ capital buffers were preserved 32 Figure 7.6. Western Balkans: Digital Payments 34 Figure 8.1. Current account deficits (CAD) improved in most countries in the region… 36 Figure 8.2. …despite continued elevated merchandise trade deficits from a historical perspective36 Figure 8.3. Services and remittances across the WB6 help contain external deficit… 37 Figure 8.4. …and exhibit a continuous increase compared with pre-pandemic years 37 Net FDI inflows have almost entirely financed the external deficit over the past Figure 8.5.  three years… 38 …although on a country basis the extent to which CADs are financed by FDI Figure 8.6.  inflows varies significantly 38 GDP growth is expected to decelerate in 2023 and gradually recover over the Figure 9.1.  medium-term39 All WB6 countries are expecting to bring inflation closer to their medium-term Figure 9.2.  targets39 Figure 9.3. Global economic developments 42 Figure 10.1. Structural transformation of the WB6 agriculture sector 44 Figure 10.2. Changes in agricultural value added in the WB6 and the EU, 2010–2022  45 Figure 10.3. Agricultural exports from the WB6 to the EU 47 Figure 10.4. Use of fertilizers and chemicals in the WB6 and the EU, 2018–2020 49 Figure 10.5. Crop yields in the WB6 vis-à-vis the EU27 (av. 2018–2020) 49 Figure 10.6. Livestock herd density in the WB6 and the EU, 2013–2020 50 Figure 10.7. GHG emissions by sector and country in the WB6, 2020 50 Figure 10.8. Agricultural budget support in the WB6 and the EU27 in percent of GDP 51 Figure 10.9. Public expenditures for agri-environmental measures in the WB6 region, 2012–202152 Figure 10.10. IPARD III allocations by the eligible WB6 countries 52 Figure 10.11. Functional composition of agricultural public expenditures in the WB6 and the EU 54 Figure 10.12. Investments in capital formation in agriculture in the WB6 and the EU 55 Figure 10.13. Diversity of agri-ecology and greening opportunities in the WB6 countries 62 vi Contents TOWARD SUSTAINABLE GROWTH Boxes Box 2.1. Toward income convergence 8 Box 4.1. The burden of care and labor market participation 17 Box 6.1. Inflation drivers in the Western Balkans since 2021: profits, then wages 27 Box 7.1. Digitalization through modernization of Western Balkans’ payment systems 33 Box 9.1. Global activity is improving but remains on thin ice 41 Box 10.1. The New EU CAP 46 Tables Table 1.1. Western Balkans Outlook, 2020–25 5 Table 5.1. Yields on Western Balkans countries outstanding Eurobonds 23 Table 10.1a. Agriculture GHG emissions per capita in the WB6 vs the EU27 (CO2eq t/pc) 48 Table 10.1b. WB6 vis-à-vis the EU27 in meeting the EGD targets for agriculture 48 Table 10.2. Agricultural growth and GHG emissions in the WB6 and the EU, 2010–2020 51 Table 10.3. Potential for adoption of CSA technologies in selected WB6 countries 56 Contents vii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Abbreviations AE Advanced Economies H2 Second Half AFOLU Agriculture, Forestry and Other ha hectare Land Use HBS Household Budget Survey AKIS Agricultural Knowledge and Innovation System HICP Harmonized Index of Consumer Prices CAD Current Account Deficit ICT Information and Communications CAP Common Agricultural Policy Technology CESEE Central, Eastern and Southeastern IFC International Finance Corporation Europe ILO International Labour Organization CO2 Carbon Dioxide IMF International Monetary Fund CPI Consumer Price Index IPARD Instrument for Pre-Accession CSA Climate-Smart Agriculture Assistance for Rural Development EAFRD European Agricultural Fund for IPPU Industrial Processes and Product Rural Development Use EC European Commission KYC Know-Your-Customer ECA Europe and Central Asia LCU Local Currency Unit ECB European Central Bank LEADER Liaison Entre Actions de Développement de l’Économie EGD European Green Deal Rurale (Links between activities for EIP European Innovation Partnership the development of rural economy) EMDEs Emerging Markets and Developing lhs left-hand scale Economies MTRS Medium-Term Revenue Strategy EU European Union NEET Not in Employment, Education or EU DG European Commission’s Training AGRI Directorate General for Agriculture NPLs Non-Performing Loans and Rural Development PMI Purchasing Managers Index F2F Farm to Fork PPG Public and Publicly Guaranteed FAO Food and Agriculture Organization PPP Purchasing Power Parity FAOSTAT Food and Agriculture Organization Corporate Statistical Database Q1 First Quarter FAS Farm Advisory Systems Q2 Second Quarter FBiH Federation of Bosnia and Q3 Third Quarter Herzegovina Q4 Fourth Quarter FDI Foreign Direct Investment R&D Research and Development FPS Fast Payment Systems rhs right-hand scale GDP Gross Domestic Product RS Republic of Srpska GHG Greenhouse Gas SBA Stand-By Arrangement H1 First Half viii Abbreviations TOWARD SUSTAINABLE GROWTH SEPA Single European Payments Area SILC Survey of Income and Living Conditions SMEs Small and Medium Enterprises SOE State-Owned Enterprise SWG Standing Working Group TARGET Trans-European Automated Real- time Gross settlement Express Transfer system TIPS TARGET Instant Payment Settlement UAA Utilised Agricultural Area UNWTO United Nations World Tourism Organization WDI World Development Indicators yoy year-on-year Western Balkan Country Abbreviations ALB Albania BiH Bosnia and Herzegovina KOS Kosovo MKD North Macedonia MNE Montenegro SRB Serbia WB6 Western Balkans 6 Note: All comparisons are year on year unless otherwise stated. Abbreviations ix Toward Sustainable Growth WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 1. Overview In the context of weakening global demand, the decline is attributable to increased inactivity. growth in the Western Balkans decelerated The recovery in the labor market also benefited over the course of 2022 and into 2023. vulnerable groups—youth and women—with Against the background of the lasting effects of youth unemployment declining to 22.7 percent shocks from Russia’s invasion of Ukraine, sticky in mid-2023, the lowest on record. This still inflation, and tighter financial conditions, compares poorly with 14.3 percent in the global demand has been weakening, and this has EU27 in June 2023, but the gap is narrowing. a divergent impact across the Western Balkans Similarly, the female labor force participation (WB6). On the one hand, the slowdown in rate has also increased in four out of the six global demand contributed to weaker-than- WB6 countries. Wage pressures, combined expected performance of industrial production with growth headwinds, are likely to slow the in the whole European Union (EU) region pace of hiring by firms in the future. and in the WB6. On the other hand, global demand has proved more resilient in services Structural factors that contribute to low and, in particular for travel, with twice as many labor force participation, coupled with people traveling globally during Q1 2023 as significant gender gaps, are constraining in the same period in 2022 (UNWTO). This further poverty reduction. With inflation has particularly benefited Albania, Kosovo, remaining at historical highs through 2023, and Montenegro, where services exports poverty rates in the region are estimated to have reached new record highs. In contrast, continue their downward trend, but at a slower weakening global demand for goods has pace. Moreover, despite some improvements weighed on Bosnia and Herzegovina (BiH), over time, and recent momentum in the post- North Macedonia and Serbia. On the demand pandemic years, labor force participation rates side, private consumption remained in general in Western Balkans continue to lag other an important growth driver, despite rising price countries with similar levels of economic pressures. development. Similarly, the gender disparities in the labor market persist in all countries, The WB6 region’s labor market continued despite a gradual increase in female labor force strengthening in 2023, against all odds, participation. but cooling is under way in some countries. The average employment rate for the All WB6 countries continue also to experience Western Balkans reached a historical high of strong year-on-year (yoy) nominal revenue 47.8 percent in June 2023. On a regional level, growth, but notable country variation in all sectors except agriculture contributed to the expenditure trends shows signs of renewed job market recovery. In fact, in 2023, labor pressures. Despite persistent external shortages continued to be among top concerns volatility, all Western Balkan countries in raised by businesses in the Western Balkans. 2023 are expected to continue running fiscal Unemployment declined in all Western Balkan deficits below or close to their 2021 levels. countries, except in Serbia but, in some cases, While maintaining elevated social protection 2 1. Overview TOWARD SUSTAINABLE GROWTH spending, all WB6 countries will continue financial sector performance demonstrates the spending more on public wages during 2023. strong resilience of the sector thanks to the To the extent that revenue increases came robust financial position of banks achieved by mostly from inflation, and less from the decisive reforms and restructuring over the past expansion of the revenue base, WB6 countries decade (following the global financial crisis) may face higher budget rigidity and less room and strong support from governments during for maneuver to reprioritize their budgets, as the COVID-19 pandemic. Nevertheless, asset fiscal space is being eroded by a parallel increase quality resilience remains under stress—as in rigid (inflation-driven) spending, such as demonstrated by the widening gap between pensions and wages. Moreover, most WB6 stage 2 and stage 3 loans, driven by the increase countries have become increasingly reliant on in the share of loans which may potentially external financing over the past few years and become non-performing. are vulnerable to the rising costs of financing resulting from monetary policy tightening. After a temporary spike in 2022, the average current account deficit (CAD) is expected Inflation pressures in the WB6 region are to improve in the Western Balkans over the easing, although price pressures persist. course of 2023, even though merchandise After peaking in October 2022 at 15 percent, trade deficits remain elevated. Some pressure average consumer price inflation in the WB6 on the merchandise deficit has been released countries has been on a downward trend, with the sharp deceleration in aggregate reaching 8.4 percent in July 2023. As of July demand and import prices that started trending 2023, core inflation also remains high, at above downward. Meanwhile, the marginal decline 5 percent. Its persistence reflects, depending in exports of goods for the WB6 region was on the economy considered, strong domestic a combination of a reduction observed in demand, a high pass-through of past shocks the range between 0.2 and 1.7 percentage to headline inflation into core inflation, the points in North Macedonia, Montenegro, lagged effects of crisis response programs, and Albania, Serbia, and Kosovo, together with an the strength of labor markets and wage growth, improvement of 1.5 percentage points in BiH. the latter especially since H2 2022. In countries Net services and remittances play an increasing with independent monetary policy, authorities role in mitigating structural merchandise trade increased key monetary policy rates throughout deficits. Moreover, since 2021, net foreign H1 2023. Despite the monetary tightening, direct investment (FDI) inflows have continued real policy rates remained negative. to play a crucial role in funding CADs, with FDI inflows in Albania, Kosovo, and Serbia The financial sector in the Western Balkans expected to fully finance their respective CADs has remained stable and resilient despite the in 2023. increasing risks, testing financial stability. Non-performing loans (NPLs) continued Growth is expected to decelerate across WB6 to follow a downward trend, declining to a countries in 2023 and then to gradually historical low (3.9 percent) in June 2023, while recover over the medium term, but risks profitability exceeded pre-pandemic levels remain tilted to the downside. Growth rates and capital buffers were preserved. Current in Europe are expected to be below the pre- 1. Overview 3 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 pandemic five-year average, suggesting that in the region. Accelerating regional integration the recovery is still weak, while the persistence would also help accelerate income convergence. of inflation suggests that monetary tightening is expected to continue. In this context, after As the WB6 agriculture sector is undergoing the strong post-COVID-19 recovery in 2021, a major structural transformation, efforts the WB6 countries are expected to witness to green agriculture are also important to slower growth in 2023, primarily owing to ensure access to the EU market and for weaker consumption and exports, reflecting the competitiveness of agriculture, rural weaker EU performance. Growth for the WB6 development, and food and nutrition region is expected at 2.5 percent in 2023, a security. Most WB6 countries have recently slight downgrade by 0.1 percent with respect included agriculture greening in their to the spring 2023 projections. The forecast for development strategies. Historically, the Albania and Montenegro has been upgraded, environmental footprint of the WB6 agriculture with 2023 growth at 3.6 and 4.8 percent, sector has been relatively low. But this has respectively. Meanwhile, the forecasts for BiH, been more an unintended outcome of still Kosovo, North Macedonia, and Serbia, have high rurality and low farming intensity rather been downgraded, with 2023 growth at 2.2, than a result of public policy and expenditure 3.2, 1.8, and 2.0, respectively. But risks to choices. Agricultural public expenditures, this growth outlook are tilted to the downside. while substantial in terms of amounts and A prolonged slowdown in the EU, as well as adequate to influence agricultural production, internal structural bottlenecks, could lead to have not yet prioritized financing of greening even further downward revisions to growth and climate-smart agriculture. It is important projections. In addition, if inflation is not for the WB6 countries to accelerate greening brought back to long-term averages as planned, of their agriculture by learning from the EU’s this may further hurt domestic demand. green transition and better utilization of the existing public funds available for agricultural Reforms are needed to consolidate the development. recovery toward sustainable growth, while negotiations with the EU hold the potential to bolster prospects in the Western Balkans. The energy crisis has highlighted the need to accelerate the green transition across Europe, including in the Western Balkans, and with a focus on key sectors, such as agriculture. It has also highlighted the importance of promoting diversification of energy sources toward renewables and energy efficiency. Reforms aiming at increasing market competition, attracting higher quality investments, and addressing barriers that limit labor force participation (especially among women), also hold the potential to boost economic growth 4 1. Overview TOWARD SUSTAINABLE GROWTH Table 1.1. Western Balkans Outlook, 2020–25 2020 2021 2022 2023e 2024f 2025f Real GDP Growth (percent) Albania -3.3 8.9 4.8 3.6 3.2 3.2 Bosnia and Herzegovina -3.0 7.4 3.9 2.2 2.8 3.4 Kosovo -5.3 10.7 5.2 3.2 3.9 4.0 North Macedonia -4.7 3.9 2.1 1.8 2.5 2.9 Montenegro -15.3 13.0 6.4 4.8 3.2 3.1 Serbia -0.9 7.5 2.3 2.0 3.0 3.8 WB6 -3.0 7.8 3.3 2.5 3.0 3.5 Real GDP Components Growth (percent) Consumption 3.6 1.3 2.0 2.6 Investment 2.4 0.4 0.6 1.2 Net exports -2.7 0.7 0.4 -0.3 Exports 7.7 2.9 2.7 3.5 Imports (-) 10.4 2.2 2.3 3.8 Consumer Price Inflation (percent, period average) 1.0 3.2 11.8 9.1 4.1 2.7 External Sector (percent of GDP) Goods exports 21.4 25.3 28.5 27.8 28.0 28.2 Trade balance -19.5 -16.9 -18.8 -16.1 -15.8 -15.6 Current account balance -8.6 -5.9 -7.8 -5.8 -5.7 -5.7 Foreign direct investment 5.3 5.8 6.9 5.9 5.7 5.6 External debt 88.9 83.9 77.3 73.1 71.6 70.2 Public Sector (percent of GDP) Public revenues 34.7 36.0 34.9 36.0 35.5 35.7 Public expenditures 42.5 38.9 37.6 38.1 37.9 37.8 Fiscal balance -7.9 -2.9 -2.7 -2.2 -2.4 -2.0 Public and publicly guaranteed debt 60.2 56.6 50.6 48.5 49.0 47.9 Sources: National statistical offices; Ministries of Finance; central banks; World Bank staff estimates. Note: e = estimate; f = forecast. 1. Overview 5 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 2. Recovery and convergence are occurring at different speeds across the Western Balkans Against the background of continued shocks demand contributed to weaker-than-expected from Russia’s invasion of Ukraine, sticky performance of industrial production in the inflation, and tighter financial conditions, whole EU region and in the Western Balkans. growth in the Western Balkans decelerated In BiH, industrial production, which accounted over the course of 2022 and into 2023. In for 25 percent of GDP (Figure 2.2), dropped 2022, the Western Balkans experienced strong by 3.9 percent during the period January to economic growth, eventually reaching pre- July 2023, largely driven by a decline in sales pandemic levels also in North Macedonia and on foreign markets totaling 11 percent, whereas Montenegro (Figure 2.1). However, growth turnover in the domestic market declined by had already started to moderate throughout 2 percent. The COVID-19 pandemic and the 2022 in the case of BiH and since early 2023 energy shock are still negatively affecting the in Albania, North Macedonia, and Serbia, performance of the industrial sector (Figure mostly due to a slowdown in global demand, 2.3). This is due to the low geographical trade which adversely affected industrial output. diversification (Figure 2.4), with a majority Macroeconomic conditions remained favorable of goods exports from Albania, BiH, North during H1 2023 in Kosovo and Montenegro, Macedonia and Serbia going to advanced despite persistent external volatility, thanks to economies (AEs) in Europe and Central Asia record growth in exports of services, mostly of (ECA), coupled with the structural challenges diaspora-related travel services in Kosovo, as facing the sector, related to the green transition, well as ICT services. value-chain disruptions, and diversification. On the other hand, global demand has Weakening global demand has had a continuously shown impetus for services and, diverse impact across the Western Balkans. in particular, travel services, with twice as many On the one hand, the slowdown in global people traveling globally during Q1 2023 as Figure 2.1. Real GDP growth in 2022 was Figure 2.2. …as weakening global demand stronger than expected, but decelerated has a diverse impact across the WB6, due over the course of 2022 and in 2023… to their different economic structures Real GDP, 2019=100 Value added, percent of GDP 115 65 110 55 45 105 35 100 25 95 15 90 5 85 -5 du ri rv y es du ri rv y es du ri rv y es du ri rv y es du ri rv y es du ri rv y es Se str Se str Se str Se str Se str Se str In Ag In Ag In Ag In Ag In Ag In Ag ic ic ic ic ic ic 80 2019 2020 2021 2022 2023e ALB BiH KOS MKD MNE SRB ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB J 2008 J 2022 Source: National statistical offices; World Bank staff. Source: National statistical offices; World Bank staff. 6 2. Recovery and convergence are occurring at different speeds across the Western Balkans TOWARD SUSTAINABLE GROWTH Figure 2.3. Industrial production Figure 2.4. …as exports are highly continues decelerating… concentrated toward advanced economies in ECA Change in industrial production, percent, 3-month moving average Percent of total goods exports, 2019 yoy 25 85 20 80 15 75 10 70 5 65 0 60 -5 55 -10 50 -15 -20 45 Ja -21 Fe -22 M -22 Ap -22 ay 2 Ju -22 Ju 22 Au l-22 Se -22 Oc -22 No t-22 De -22 Ja -22 Fe 23 M -23 Ap -23 ay 3 Ju -23 23 40 M r-2 M r-2 n- n- n- c c g n b ar p v b ar De ALB BiH KOS MKD MNE SRB ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB Source: National statistical offices; World Bank staff. Source: WDI. in the same period in 2022 (UNWTO). This increase of 17 percent during the period January has particularly benefited Albania, Kosovo, to June 2023. In Kosovo, monthly indicators, and Montenegro, where services exports have including those on the external sector, firms’ experienced new record highs. sales and international travel data show that the impact from consumption as well as service On the demand side, private consumption exports on growth was strong throughout the remained in general an important growth first three quarters of 2023. In Montenegro, driver, but rising price pressures have GDP expanded by 6.6 percent1 in H1, driven started putting a dent into households’ by personal consumption, which grew by purchasing power ( Figure 2.5). In Albania, 10.4 percent in real terms, underpinned by an private consumption grew by 3 percent in increase in public sector wages, employment Q1 2023 (yoy), supported by increasing gains, and household borrowing. In North employment and wages, strong consumer Macedonia, consumption eased to 1.6 percent confidence, relatively low interest rates and (down by 1.1 percentage points from Q4 2022) benign credit conditions, despite monetary as continued high inflation put a dent on the policy normalization. Increased income from household purchasing power. Conversely, in employment, credit growth, business and Serbia, consumption, together with investment, consumer sentiment indicators, and strong tax made negative contributions to growth in H1 revenues, suggest an increasing contribution 2023. to growth from consumption, as well as investment and net exports, in Q2 and Q3 The negative contribution to growth from net 2023. In BiH, private consumption contracted exports in H1 2023—except for Montenegro in Q1 2023, as remittance inflows dropped and Serbia—and from agriculture speaks by 4.8 percent in real terms; nonetheless, it is to the volatility of the growth model. Small expected to pick up in Q2 and Q3 of 2023, economies are subject to a variety of risks, supported by an average after-tax real wage including dependence on imports of essential 1 All comparisons are year-on-year, unless otherwise indicated. 2. Recovery and convergence are occurring at different speeds across the Western Balkans 7 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 2.5. Consumption remains an Figure 2.6. Some countries display more important growth driver, despite rising growth volatility than others price pressures Contributions to growth, percent Real GDP growth std 2007Q1–2023Q3 15 18 MNE 16 10 14 ALB 5 12 10 0 8 KOS 6 BiH MKD -5 SRB 4 -10 2 20 2 e 20 2 e 20 2 e 20 2 e 20 2 e 20 2 e 20 2 e 2 2 2 2 2 2 2 23 23 23 23 23 23 23 20 20 20 20 20 20 20 0 ALB BiH KOS MKD MNE SRB WB6 0 2 4 6 8 10 12 14 16 18 20 Agriculture, value added (percent of GDP) J Consumption J Investment J Net exports Q Real GDP growth (percent) Source: National statistical offices; World Bank staff. Source: National statistical offices; World Bank staff. goods, vulnerability to external shocks, lack of This is especially the case of Albania, where scale, limited connectivity, highly concentrated dependence on climate conditions is high economic structures, reliance on external due to the prominent role of sectors such as financing, and susceptibility to natural disasters agriculture and hydro energy production. The and climate change. This contributes to an Spotlight sheds further light on the role of uneven convergence pattern across the six agriculture for the economic development of countries (see Box 2.1) and translates into the Western Balkans and its contribution to very volatile economic growth (Figure 2.6). greening their economies. Box 2.1. Toward income convergence The Western Balkans countries have made significant progress in terms of income convergence with AEs. Income convergence is typically measured by comparing the per capita income of a country with that of a more prosperous nation, in this case the EU average. For the Western Balkans, this ratio ranged from 27.3 percent in Kosovo to 50 percent in Montenegro in 2022, indicating that the countries’ standards of living are between one- quarter and one-half that of the EU average. However, not all countries have achieved the same level of convergence, nor have they advanced at the same speed. By examining the average convergence velocity, or the rate of change in income convergence per decade, it is evident that Montenegro and Serbia have exhibited positive convergence velocities in recent decades. The other economies have only achieved negative convergence velocity, meaning that the rate of convergence has been 8 2. Recovery and convergence are occurring at different speeds across the Western Balkans TOWARD SUSTAINABLE GROWTH (Box 2.1 continued) decelerating. For example, the convergence velocity for Albania has decreased from an average of 5 percentage points per decade after 1997 to about 2.7 percentage points per decade more recently. Human capital and firm productivity emerge as the two common avenues for boosting growth and productivity, hence convergence, across the WB6 countries. Other areas concern economic management, reform of state-owned enterprises (SOEs), and institutional strengthening in general. Enhancing the management of public investment is also crucial, as shortcomings in the quantity and quality of infrastructure capital undermine the returns to private investment. Coordinated policies and investments for regional integration can also generate significant economy-wide benefits. For example, reducing waiting times at the border has the same impact on exports as lowering tariffs in the EU market. Finally, the green transition and the need for a sustainable economic model are also seen as opportunities for the WB6 countries.2 Figure 2.7. The Western Balkans’ standards of living are between one-quarter and one-half that of the EU average, but convergence is moving at different speeds Change in convergence ratio per decade, 1997–2022, percentage points Convergence ratio (2022) 50 Slowing convergence Accelerating convergence MNE 45 SRB 40 MKD BiH 35 ALB 30 KOS 25 20 -2.5 -2.0 -1.5 -1.0 -0.5 0 0.5 1.0 1.5 2.0 2.5 Convergence velocity (1997–2022) Source: WDI; World Bank staff. Note: Calculations based on GDP per capita, PPP (constant 2017 US$). For Kosovo, data are available starting 2008. 2 See World Bank Country Economic Memorandum (CEM) for Serbia (2020), Albania (2021), Kosovo (2022), Montenegro (2023) and BiH (forthcoming). 2. Recovery and convergence are occurring at different speeds across the Western Balkans 9 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 3. The labor market remained strong against all odds, but cooling is underway in some countries3 The region’s labor market continued The average employment rate for the strengthening in 2023 and employment Western Balkans reached a historical high levels reached historical highs in several of 47.8 percent in June 2023.4 Although countries (Figure 3.1). The growth recovery still lower when compared with an average in 2022–23 brought employment to new 54.5 percent for the EU27 in June 2023, this is highs: between mid-2022 and mid-2023, an increase of 1.6 percentage points since mid- an additional 103,000 jobs were created 2022, underscoring the continued labor market in the region, of which Albania, BiH, and recovery and convergence with the EU. In fact, Montenegro showed the strongest gains. in Albania and Montenegro, the employment This was followed by Kosovo, where the Tax rate at 57.1 and 55.9 percent, respectively, has Administration reported that the number of already surpassed the EU27 rate. The largest personal income tax payers increased by close increase in the employment rate was recorded to 5 percent in Q2 2023 (yoy), equivalent to in Montenegro (Figure 3.1). In Kosovo, despite about 29,000 jobs being added. However, recent gains, only 34 percent of the working- North Macedonia and Serbia have seen growth age population is employed. North Macedonia in employment levels decelerate in mid-2023 observed a decline in the annual employment affected by a slowdown in external demand and rate after the recent methodological changes. a struggling manufacturing sector (Figure 3.2). Average annual employment growth in mid- 2023 for the region was 1.5 percent. Figure 3.1. The employment rate reached Figure 3.2. …but a slowdown is underway a historical high in the Western Balkans… in most countries Employment rate, 15+ years, percent, and H1 2023–H1 2022 change, Change in employment, percent, 3-month moving average yoy percentage points 1.1 10 25 WB6 20 KOS 2.5 8 15 1.0 6 10 BiH 5 -1.9 4 MKD 0 0.8 2 -5 SRB -10 5.0 0 MNE -15 2.4 -2 -20 2 ALB 22 22 22 3 3 02 02 02 0 0 0 -2 -2 -2 -2 -2 -2 Q3 Q1 Q2 Q4 0 10 20 30 40 50 60 Q1 Q2 J H1 2023 J H1 2022 ▬ ALB ▬ BiH ▬ KOS ▬ SRB ▬ WB6 ▬ MKD (rhs) ▬ MNE (rhs) Source: National statistics offices; World Bank staff estimates. Source: National statistics offices; World Bank staff estimates. Note: 15–64 years for Kosovo. 3 This analysis was affected by: (i) delayed publishing of Labor Force Survey (LFS) data in Kosovo and by (ii) a sampling revision in BiH, Montenegro, and North Macedonia that reduced comparability with previous LFS data. Using tax administration data, and unemployment data for Kosovo helped provide an approximate picture of the labor market in 2023. Serbia also revised the 2022 LFS data. 4 The employment rate is the region’s simple average for the population aged 15–64 years for Kosovo and 15+ for all other WB countries. 10 3. The labor market remained strong against all odds, but cooling is underway in some countries TOWARD SUSTAINABLE GROWTH On a regional level, all sectors except and North Macedonia), encourage diaspora agriculture contributed to the job market workers to return back home (45 percent of recovery (Figure 3.3). During the summer, responding firms, with 62 percent in Kosovo) a record strong tourism sector boosted or transfer knowledge back home (34 percent employment, followed by a rise in trade, ICT, of responding firms), incentivize private as well as transport. The construction sector businesses to offer more attractive conditions also observed an increase in employment across for diaspora to return (33 percent of responding countries, including in North Macedonia firms), improve institutional effectiveness where construction of the Corridor VIII and Xd (28 percent of responding firms), and facilitate highways started. Employment in agriculture immigration of skilled labor force from third continued to shrink, with the exception of countries (17 percent of responding firms). Kosovo, BiH, and Montenegro. Unemployment declined in all Western In fact, in 2023, labor shortages continued to Balkan countries, except in Serbia. The be among top concerns raised by businesses unemployment rate (ages 15+) in the Western in the Western Balkans  (Figure 3.4). A Balkans declined by 0.9 of a percentage point continued services sector recovery resulted in a to 11.7 percent in mid-2023, the lowest on the sharp increase in unfilled vacancies, and a surge record (Figure 3.5). This is still double the EU27 in imported labor from Asian countries. Some unemployment rate for ages 15+ which stood of the countries of the Western Balkans— at 5.8 percent in mid-2023. Serbia has seen a Albania, North Macedonia, and Serbia—have rise to 9.6 percent compared with 8.9 percent already liberalized their work permit regimes a year ago as more people entered the labor to enable cross-border labor mobility, but this force. The unemployment rate in BiH dropped does not seem to be enough to fill vacancies. significantly, by 2.6 percentage points yoy, Businesses are requesting authorities to largely on account of a decline in the activity deploy policies to retain workers (70 percent rate. In North Macedonia, the unemployment of respondents and the highest in Albania rate also dropped, on account of more jobs for Figure 3.3. Services and construction had Figure 3.4. Businesses require policies the highest job creation rates to retain the labor force and attract diaspora to the Western Balkans labor market Change in employment, percent, yoy Percent of firm respondents 7.5 8 100 6.4 6.2 6.1 6 5.4 80 5.3 4.7 4.4 3.9 3.7 3.6 4 3.3 60 2.7 2.3 2.1 1.9 1.8 1.5 2 1.5 1.4 1.3 1.3 40 1.2 1.2 0.9 0.9 0.6 0.2 0.1 0 20 -0.3 -0.4 -2 -1.6 0 Improve institutional effectiveness to retain labour of skilled labour to encourage our Encourage our Introduce policies force conditions to our Facilitate emigration force from the third countries back home back home businesses to offer Introduce policies diaspora to return diaspora to transfer knowledge Incentivise private more attractive diaspora to return -4 -3.6 -3.7 -3.9 -3.9 -4.2 -4.3 -5.0 -6 -5.7 -8 General Agriculture Industry Construction Services government J Q2-21 J Q4-21 J Q1-22 J Q2-22 J Q3-22 J Q4-22 J Q1-23 J Q2-23 J WB6 J ALB J BiH J KOS J MKD J MNE J SRB Source: National statistics offices; World Bank staff estimates. Source: Balkan Business Barometer 2023 survey. 3. The labor market remained strong against all odds, but cooling is underway in some countries 11 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 3.5. Unemployment rate declined Figure 3.6. Inactivity declined in most to a new low countries as labor market strengthened Unemployment rate, 15+ years, percent, and H1 2023–H1 2022 change, Inactivity rate, 15+ years, percent, and H1 2023–H1 2022 change, percentage points percentage points -1.0 -0.6 WB6 WB6 0.1 -2.4 SRB ALB -0.4 -4.9 ALB MNE -2.8 -0.9 KOS SRB -3.0 3.1 BiH MKD -1.4 0.5 MKD BiH -1.5 -1.6 MNE KOS 0 3 6 9 12 15 18 0 9 18 27 36 45 54 63 J H1 2023 J H1 2022 J H1 2023 J H1 2022 Source: National statistics offices; World Bank staff estimates. Source: National statistics offices; World Bank staff estimates. Note: 15–64 years for Kosovo. Note: 15–64 years for Kosovo. the younger cohort and the exit to inactivity declined compared with 2022, but annual of the older cohorts. Yet, in both BiH and comparability is hampered by methodological North Macedonia, the unemployment rate changes. remains high at 13.1 percent, the highest rate recorded in the WB6 region in Q2 2023. In The recovery in the labor market also Montenegro, strong economic activity, and in benefited vulnerable groups—youth and particular in the tourism sector, helped push women. Youth unemployment declined to down the unemployment rate to 12.9 percent 22.7 percent in mid-2023—the lowest on by mid-2023 and more people moved to record—and was down by 2.5 percentage points the labor market. A similar development is yoy (Figure 3.7). This still compares poorly with observed in Albania, ahead of the summer 14.3 percent in the EU27 in June 2023, but tourism season—its unemployment rate fell the gap is narrowing compared with a year ago. to 10.7 percent in mid-2023 and the inactive Around 1,800 young people were moved out of population declined. unemployment over the year, with the largest improvements recorded in BiH, while Albania The labor force participation rate increased and Serbia saw youth unemployment rising. to a new high. The annual decline in In Serbia, the percentage of young people who unemployment reached 25,900 people by are not in employment, education or training June 2023 and was lower than the rise in (NEET) also declined by 0.8 of a percentage employment, which meant that more people point to 11.7 percent. Kosovo and Montenegro entered the labor market and that inactivity have the lowest youth unemployment rates in declined (Figure 3.6). The participation rate the region—below 20 percent—while, despite reached 54.1 percent, up by 1.2 percentage improvements, the youth unemployment rate points compared with mid-2022. Montenegro in BiH is the highest in the region, at over and Albania are leading the group with 64.2 29 percent. However, most of the decline in and 63.9 percent, respectively, whereby youth unemployment was due to exits from the Montenegro saw the largest gain over the year. labor force rather than increased employment. In North Macedonia, the participation rate 12 3. The labor market remained strong against all odds, but cooling is underway in some countries TOWARD SUSTAINABLE GROWTH Figure 3.7. Youth unemployment rate Figure 3.8. More women returned to the declined to a new low labor market than men in 2023, except in Kosovo and North Macedonia Youth unemployment rate, 15–24 years, percent Labor force participation rate 50 80 70 40 60 50 30 40 30 20 20 10 10 0 Dec-22 Jun-23 Dec-22 Jun-23 Dec-22 Jun-23 Dec-22 Jun-23 Dec-22 Jun-23 Dec-21 Dec-22 0 ALB BiH KOS MKD MNE SRB WB6 ALB MNE SRB MKD BiH KOS J 2019 J 2020 J 2021 J Q2 2023 Q Men Q Women Source: National statistics offices; World Bank staff estimates. Source: National statistics offices; World Bank staff estimates. Note: 15–29 years for Albania. The female labor force participation rate income. The minimum wage in Montenegro increased in four countries. Except for Kosovo remained unchanged in 2023 relative to the and North Macedonia, the female labor force previous year, after the substantial increase in participation rate increased but, at 45.7 percent 2022. for the region, it was still lagging that of men (at 63.6 percent) in mid-2023 (Figure 3.8). Minimum wages increased twice as fast in The largest improvement was in Montenegro the Western Balkans compared with EU (5.5 percentage points) where the rate reached peers. The rise in minimum wages in the 58.1 percent, the same as in Albania. region of around 43 percent on average since mid-2021 was almost double that of EU Strong labor demand, earlier shortages, and peers, at 22 percent (Figure 3.9). The highest high inflation in the Western Balkans have increase in minimum wages was observed in created wage pressures. The trend of rising Montenegro, where the minimum wage in minimum wages in the region continued September 2023 stood at 60 percent above the throughout 2023. Minimum wages increased level from H2 2021. Montenegro’s minimum by 9.9 percent in FBiH and 12.5 percent wage is more than three times higher than the in North Macedonia in accordance with a lowest minimum wage observed in the region recently introduced indexation mechanism (in Kosovo). The ratio of minimum to average with average wage and consumer price growth. wage is above 50 percent in Albania, North In Albania and Republic of Srpska minimum Macedonia, and Montenegro. wages increased, through government decision, by 17.6 and 18.7 percent, respectively. In Such wage pressures, combined with growth Kosovo, the minimum wage was raised to headwinds, are likely to slow the pace of EUR 264 over the summer, but the decision hiring by firms in the future. Around three- by Parliament is currently under review by quarters of the Western Balkan firms surveyed the Constitutional Court. Serbia’s minimum in the 2023 Balkan Barometer have seen labor wage was increased by 14.3 percent, along with and other costs, including energy costs, increase an increase in the threshold for non-taxable (Figure 3.10). As firms try to offset the impact 3. The labor market remained strong against all odds, but cooling is underway in some countries 13 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 3.9. Gross minimum wages Figure 3.10. Labor and other costs increased twice as fast compared with increased over the last year EU peers over the past two years in EUR terms, 2021–23 Percent of firm respondents 1,400 100 90 1,200 80 1,000 70 800 60 50 600 40 400 30 20 200 10 0 0 A V K T U N S B iH NE RS KD B ES LV HR KO SV AL SR LT SV WB6 ALB BiH KOS MKD MNE SRB FB M M J 2021 H2 Q 2023 H2 J Decreased J Remained unchanged J Increased Sources: Eurostat, National statistics offices; World Bank staff Source: Balkan Business Barometer 2023 survey. estimates. Note: LVA=Latvia; HRV=Croatia; SVK=Slovakia; EST=Estonia; LTU=Lithuania; SVN=Slovenia; FBiH=Federation of Bosnia and Herzegovina; RS=Republic of Srpska. of higher labor costs that add to pressures from other input prices, including energy, defensive restructuring can take place, as is already happening in the car supply industry where global demand is on the decline. 14 3. The labor market remained strong against all odds, but cooling is underway in some countries TOWARD SUSTAINABLE GROWTH 4. Low labor force participation, coupled with significant gender gaps, constrains further poverty reduction For 2023, poverty rates in the region are Inflation remains high in the region. By July estimated to continue their downward of 2023, food inflation remained high in the trend, which had slowed down due to the region at 14.6 percent. These levels, while lower COVID-19 pandemic and the subsequent than the ones registered in the same month of inflation shocks of 2022. The pre-pandemic 2022, are 12.3 percentage points higher than poverty reduction trend in the Western Balkans the inflation levels registered in July of 2021, was halted in 2020 by the impact of the crisis, for the regional average. Energy inflation which resulted in significant job losses and an increased marginally in July 2023 compared average contraction of GDP by 3 percent in with July 2022, but remained at levels below 2020. While the economic recovery in 2021 food inflation. Serbia stands out as the country was strong, with 7.8 percent GDP growth with the highest energy inflation rate at overall for the Western Balkans, and reflected in 22.1 percent, while Albania has the lowest, at a reduction of 2.8 percentage points in regional less than 1 percent as of July of 2023. Food poverty by 2021, the poverty reduction pace inflation also remains the highest in Serbia decelerated in 2022 as households’ welfare at 21.1 percent, compared with 6 percent in was affected by soaring food and energy prices Kosovo, the country with lowest food inflation (Figure 4.1). in the region by July of 2023. Figure 4.1. Poverty is projected to The less well-off consistently face higher continue to fall in the region, but at a slower pace inflation rates compared with the better- Poverty headcount (percent of population living on less than $6.85/ off due to differences in the composition day 2017 PPP) 40 of consumption baskets. Furthermore, as discussed in the Spring 2023 Regular 30 Economic Report (World Bank, 2023), if 29.1 26.6 household-specific inflation were used instead, 23.1 20 19.6 19.7 16.9 15.8 15.0 14.1 the estimates for poverty and inequality rates, 13.1 as well as the profile of the poor, would differ 10 systematically, with the largest differences in 0 case of higher inflation. 16 17 e e e e e f f f 23 24 25 18 19 20 21 22 20 20 20 20 20 20 20 20 20 20 Source: World Bank staff estimates and projections based on 2018 Historically, employment and labor income income data from the Survey of Income and Living Conditions (SILC) for Montenegro; 2019 for Albania, and North Macedonia, 2020 Serbia; have explained a significant share of and 2017 Household Budget Survey (HBS) for Kosovo. Note: Income measures in the SILC and consumption measures poverty reduction in the region. While the in the HBS are not strictly comparable. Welfare is estimated in US dollars using 2017 PPPs. The regional estimate excludes BiH due to unavailability of up-to-date household survey a lack of comparable data. Forecasts are based on GDP per capita in constant LCU, e = estimate, f = forecast. data for all countries in the region does not allow to ascertain the actual magnitude of the increase in poverty in 2020 and subsequent reduction, past analysis has highlighted the 4. LOW LABOR FORCE PARTICIPATION, COUPLED WITH SIGNIFICANT GENDER GAPS, CONSTRAINS FURTHER POVERTY REDUCTION 15 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 critical role of employment and labor income Despite some improvements over time, labor in explaining poverty dynamics. In Albania, force participation rates in the Western between 2016 and 2019, 71 percent of the Balkans continue to lag other countries with reduction in the poverty rate can be attributed similar levels of economic development. to labor income growth. In Kosovo, while labor Data for H1 2023 suggest that employment income growth can explain half of the poverty growth has resumed in the region, with an reduction that the country experienced between average annual growth rate of 1.5 percent, 2017 and 2019, changes in employment can but challenges remain on the horizon (see explain two-thirds of the reduction in the Section 3). Labor force participation rates in poverty headcount. Employment and labor Western Balkan countries remain lower than income have been important drivers of poverty those predicted by their level of GDP per dynamics not only in recent years, but over a capita, with the sole exception of Albania. longer horizon. In North Macedonia for the Notably, this is not only on account of low period 2010–2020 and in Serbia between labor force participation among women; labor 2013 and 2020, labor income explained 51 force participation rates among men, while and 59 percent of their respective declines in higher than women’s, are actually even further the poverty rate. Increases in minimum wages below those predicted by the countries’ level of across the region since 2021, mostly in response development than the rates for women (Figure to higher inflation (see Section 3) could be 4.2). Furthermore, labor market attachment beneficial for low-income households, and for in the region lags significantly behind the in-work poverty, but could also pose challenges EU27 average labor force participation rate of to generate more employment in the future, 74.5 percent in 2022, particularly in Kosovo despite consensus estimates of employment (38.6 percent) and BiH (47.6 percent). effects of increasing wages of minimum-wage earners (Grunberger et al., 2021).5 Figure 4.2. Male and female labor force participation (15+) and GDP per capita, latest data Labor force participation rate, percent male Labor force participation rate, percent female 100 100 90 90 80 80 70 ALB 70 SRB MKD BiH 60 MNE 60 ALB SRB 50 KOS 50 MNE MKD BiH 40 40 30 30 20 20 KOS 10 10 0 0 6 8 10 12 6 8 10 12 Log (GDP per capita) Log (GDP per capita) Q WB6 Q ECA Q Rest of the world ▬ Lowess fit Q WB6 Q ECA Q Rest of the world ▬ Lowess fit Source: World Development Indicators. Note: Latest year available for each country. 5 Grunberger, Klaus, Edira Narazani, Stefano Filauro, and Aron Kiss. 2021. “Social and fiscal impacts of statutory minimum wages in EU countries: A microsimulation analysis with EUROMOD.” Joint Research Centre Working Papers on Taxation and Structural Reforms No. 06/2021, European Commission, Brussels. 16 4. LOW LABOR FORCE PARTICIPATION, COUPLED WITH SIGNIFICANT GENDER GAPS, CONSTRAINS FURTHER POVERTY REDUCTION TOWARD SUSTAINABLE GROWTH Gender disparities in the labor market persist Figure 4.3. Significant differences between male and female labor force in all countries, despite a gradual increase in participation pose a major challenge female labor force participation. Among the Participation rate male-female gap, percentage point difference countries in the region, Kosovo stands out as 50 45 the one that has made progress in narrowing 40 the gap between male and female labor 35 participation. In 2017, the gap was as wide 30 25 as 45 percentage points but, by 2022, it had 20 reduced to 33 percentage points. Nevertheless, 15 Kosovo continues to present the largest gap in 10 5 the region, followed by North Macedonia and 0 BiH, at 24 percentage points, and by other 2016 2017 2018 2019 2020 2021 2022 ▬ ALB ▬ BiH ▬ KOS ▬ MNE ▬ MKD ▬ SRB countries in the region at around 14 percentage Source: Labor Force Survey for each country. Note: All estimations for the 15–64 population except for BiH which points (Figure 4.3). uses the 15–89 population. Women are particularly affected by the than 2 percent of the elderly in need of care lack of both child and elderly care services in Albania receive formal care services and that impact their (formal) labor market that 22 percent of the population aged 65 participation. The time required to care for or above need long-term care, causing them school-age children is high (see Box 4.1). to rely heavily on informal care provision by According to a 2014 World Bank study, formal family members.6 Given the lack of access to childcare use outside the home in the region child- and elderly-care services, combined is low, reaching 24 percent of households with with social norms across many communities at least one child under age 7, which is below in the Western Balkans, both child and elderly the EU15 average of 35 percent. Similarly, care responsibilities fall disproportionately on the use of formal elderly care ranged from the female members of households, affecting 0 to 4.8 percent for countries in the region. their ability—and aspirations—to participate More recently, the ILO estimated that less actively in the labor market. Box 4.1. The burden of care and labor market participation Parents of young children face a tough balancing act between the responsibility of caring for their kids and earning an income. The limited supply of childcare centers in all countries in the Western Balkans makes it challenging for parents to find suitable care for their children. Parents may have to resort to less-than-ideal options such as leaving their children with untrained caregivers, quitting their jobs, or working part-time to care for their children. The problem is not just early childhood care. Indeed, even once children enter primary school, the challenge of balancing work and childcare persists. With vacations and 6 “Long-term care for the elderly in Albania: Challenges and key policy issues”. ILO (2022). 4. LOW LABOR FORCE PARTICIPATION, COUPLED WITH SIGNIFICANT GENDER GAPS, CONSTRAINS FURTHER POVERTY REDUCTION 17 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 (Box 4.1 continued) days off, as well as the fact that children are only in school for about 5 hours a day, parents still need to find care for their children during these gaps. This can be particularly challenging for single parents or households where both parents must work full-time. Figure 4.4 shows that children in primary school are in school for half the working hours of a full-time worker. Figure 4.4. Share of regular full-time working hours children spend in public school SCHOOL HOURS WO RKING HOURS Source: World Bank staff. Thus, the shortage of accessible and affordable pre-school and afterschool care can profoundly impact parents and families. It can limit parents' ability to return to work or force them to make difficult choices about the quality of care their children receive. Besides childcare, caring for an elderly parent is not an easy task and can be just as challenging, if not more so. In many cases, it requires significant time, effort, and resources, making it difficult for household members to maintain a full-time job. The physical and emotional demands of elderly care, such as medication management, transportation, and assistance with daily activities, can be overwhelming and exhausting, leading to burnout and stress. In addition, the financial burden of elderly care can be significant, especially if the parent requires specialized medical attention or long-term care. 18 4. LOW LABOR FORCE PARTICIPATION, COUPLED WITH SIGNIFICANT GENDER GAPS, CONSTRAINS FURTHER POVERTY REDUCTION TOWARD SUSTAINABLE GROWTH 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation Fiscal policy in the Western Balkans remains that the country ran a fiscal surplus in 2022. on a revenue-driven consolidation path, but North Macedonia, meanwhile, is expected to notable country variation in expenditure maintain the highest level of fiscal deficit in the trends shows signs of renewed pressures. region, at the same level as in 2022, at around Despite persistent external volatility, all 4.5 percent of GDP. Western Balkan countries in 2023 are expected to continue running fiscal deficits below, or Inflation boosted revenue growth, which close to, their 2021 levels. The WB6 regional remains strong. All WB6 countries continue to average7 fiscal deficit is expected to drop by 0.5 experience strong yoy nominal revenue growth. of a percentage point of GDP in 2023, down Except for Serbia, revenues in percent of GDP from 2.7 percent of GDP in 2022 (Figure are also expected to grow across WB6 countries, 5.1). The annual improvement in 2023 is gaining 1.1 percentage points of GDP, on primarily driven by expectations of significant average. Montenegro, Albania, and North consolidation in Montenegro (3.1 percentage Macedonia are expected to see even higher- points of GDP), Albania (1.2 percentage points level increases of over 1 percentage point of of GDP), and Serbia (0.2 of a percentage point GDP. Moreover, in Montenegro, the increase of GDP). In Kosovo, the level of fiscal deficit in revenue coincides with a contraction of is expected to remain low—below 1 percent expenditure as a percentage of GDP, leading to a of GDP—and broadly the same as in 2022. more significant improvement in fiscal balance. BiH is also expected to run a fiscal deficit level In Serbia, contained expenditures reflecting that does not exceed 1 percent of GDP, but the retraction of crisis support measures are its balance will nevertheless deteriorate given expected to lead to an improvement in the Figure 5.1. Montenegro, Albania, and Figure 5.2. …but consolidation is driven Serbia set to experience an improvement by contained expenditures only in Serbia in fiscal balances… and Montenegro Contribution to change in the fiscal balance in 2023e, percent of GDP 1 4 ↑Reduced revenues, increased spending 0 3 2 -0.6 -1 -0.8 1 -2 -2.0 0 -2.2 -2.5 -3 -2.8 -1 -4 -2 -4.5 -5 -3 ↓Increased revenues, reduced spending -6 -4 MKD SRB ALB MNE BiH KOS WB6 BiH KOS MKD SRB ALB MNE WB6 J 2021 J 2022 J 2023e J Expenditure J Revenue Q Change in fiscal balance Sources: National statistical offices; Ministries of Finance; World Bank Sources: National statistical offices; Ministries of Finance; World Bank staff estimates. staff estimates. 7 From here on, the regional average refers to the regional unweighted arithmetic average. 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation 19 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 fiscal balance, despite a drop in revenue relative While maintaining elevated social protection to GDP. On the other hand, BiH and North spending, all WB6 countries will also Macedonia, despite experiencing significant spend more on public wages during 2023. revenue growth, are expected to experience a Social protection spending during the year is deterioration of fiscal balances against a surge expected to remain elevated, at an average of in expenditure (Figure 5.2). 12.9 percent of GDP, and to exceed 15 percent of GDP in BiH and North Macedonia (Figure After two years of post-pandemic 5.4). In Serbia and Montenegro, despite normalization, WB6 average expenditure contractions in total spending as a percentage levels are growing again in 2023. In 2022, of GDP, social protection spending is expected expenditures in the region contracted by an to increase. Kosovo is the only country in average of 1.3 percentage points of GDP. the region where social spending is expected In 2023, expenditures, as a percentage of to contract compared with a year before. On GDP, will only continue to drop in Serbia the other hand, and after a year of lower real and Montenegro (by close to 1 percent of public wages in 2022, the whole region is GDP). In Albania, expenditures are expected expected to see continued increases in public to only marginally increase, while in North wage compensation. Nonetheless, in North Macedonia, BiH and, to a lesser degree, Macedonia and Kosovo, increased capital Kosovo, expenditures are set to grow (Figure expenditure is expected to be the main driver 5.3). Pressures for recurrent expenditure of expenditure growth. remain high and continue to drive expenditure growth. Capital expenditures are expected Inflation-supported revenue gains may lead to provide a positive, yet relatively smaller to structurally higher expenditure pressures contribution to growth. In North Macedonia, and budget rigidity. Most WB6 countries have capital expenditure is expected to increase by been on a post-pandemic consolidation trend, 2.5 percentage points of GDP over 2023. which was largely driven by positive revenue Figure 5.3. The share of social benefit Figure 5.4. …while all WB6 countries have remains high… turned to higher spending on public wages Percent of GDP Contribution to change, in percent of GDP 50 4 40 3 30 2 1 20 0 10 -1 0 2022 2023e 2022 2023e 2022 2023e 2022 2023e 2022 2023e 2022 2023e 2022 2023e -2 SRB MNE BiH MKD ALB KOS WB6 MNE SRB ALB KOS BiH MKD WB6 J Wage bill J Social benefits J Wage bill J Social benefits J Capital expenditures Q Total expenditures J Capital expenditures Q Total expenditures Sources: National statistical offices; Ministries of Finance; World Bank Sources: National statistical offices; Ministries of Finance; World Bank staff estimates. staff estimates. 20 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation TOWARD SUSTAINABLE GROWTH performance, but also by a gradual retraction of is the only country where PPG as a share of crisis-related measures. The continued impetus GDP is expected to increase in 2023, by 0.6 of of inflation on revenue will, however, not be a percentage point, as the country undertakes permanent. At the same time, the retraction of large capital projects. The most pronounced crisis measures is being replaced with increases decline in PPG debt to GDP is expected for in rigid expenditure categories, such as wages Montenegro—from 71.7 percent of GDP in and pensions. To the extent that revenue gains 2022 to 64.2 percent of GDP in 2023—due came mostly from inflation, and less from the to the highest nominal growth of GDP, but expansion of the revenue base, WB6 countries also due to a much stronger-than-expected may face higher budget rigidity and less room revenue performance. Albania and BiH’s PPG for maneuver to reprioritize their budgets, as debt-to-GDP ratios are estimated to decline by fiscal space is being eroded by a parallel increase 2.3 and 2 percent of GDP, respectively, while in rigid (inflation-driven) spending, such as Serbia’s public debt remained at similar levels pensions and wages. as in 2022. In Kosovo, large amortizations in 2023 and limited new borrowing are estimated Owing to solid fiscal performance and the to result in a decline in PPG debt to GDP from denominator effect, public and publicly 19.9 percent in 2022 to 18.6 percent in 2023. guaranteed debt for the region declined as Contingent liabilities coming from SOEs and a share of GDP. While growth performance public private partnerships remain significant is mixed across the region, GDP deflators fiscal risks, especially in Albania and Serbia. remain high in all countries, resulting in higher-than-expected nominal GDP. This External PPG debt is estimated to have has led to a reduction of public and publicly declined marginally (Figure 5.6). The guaranteed (PPG) debt as a share of GDP estimated decline of external PPG to GDP in most countries (Figure 5.5). The average from 33.3 to 32.0 percent for the region is a PPG debt-to-GDP ratio for the region is result of higher nominal GDP and limited estimated to decline to 48.5 percent of GDP new borrowings. Montenegro recorded the from 50.6 percent in 2022. North Macedonia strongest decline of 5.6 percentage points of Figure 5.5. PPG debt is declining in all Figure 5.6. …and the trend is similar for countries except North Macedonia… external debt Percent of GDP Percent of GDP 90 100 80 70 80 60 60 50 40 40 30 20 20 10 0 0 MNE ALB MKD SRB BiH KOS WB6 MNE MKD SRB ALB BiH KOS WB6 J 2023e Q 2022 ▬ Pre-pandemic peak ▬ Pre-pandemic low J 2023e Q 2022 ▬ Pre-pandemic peak Sources: National statistics offices; World Bank staff estimates. Sources: National statistics offices; World Bank staff estimates. 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation 21 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 GDP, followed by BiH (-1.6 percentage points Tightening financial conditions are being of GDP). The decline is estimated to be only reflected in increased cost of financing for marginal for North Macedonia and Albania, the WB6. Most WB6 countries have become while Serbia and Kosovo’s external PPG to increasingly reliant on external financing GDP is expected to remain at the same levels over the past few years and are vulnerable to as in 2022. In April 2023, the IMF approved the rising costs of financing resulting from for Kosovo a 24-month precautionary Stand- monetary policy tightening. After a pause By Arrangement (SBA) of EUR 100 million in 2022, most Western Balkan countries and an arrangement under the Resilience and returned to the markets in 2023, but the Sustainability Facility of EUR 78 million, environment is vastly different. In January, the first of such operation in Europe. Kosovo Serbia issued two Eurobonds—a five-year therefore joins Serbia and North Macedonia Eurobond of US$750 million at a coupon rate in having an active engagement with the of 6.25 percent, and a 10-year Eurobond of IMF, with Serbia’s SBA signed in December US$1 billion at a coupon rate of 6.5 percent. 2022 and North Macedonia’s Precautionary In March, North Macedonia issued a four-year and Liquidity Line signed in November Eurobond of EUR 500 million at a coupon rate 2022. In 2023, the World Bank provided of 6.96 percent. In June, Albania issued a EUR additional support through the development 600 million at a coupon rate of 5.9 percent. policy loans approved for Kosovo (EUR All these Eurobond placements come at a 50.6 million), Albania (EUR 110 million), much greater cost for the countries than in and Serbia (EUR 149.9 million), which aims the previous two years, when Serbia placed to assist in strengthening the resilience of these a Eurobond at a coupon rate of 1 percent countries’ economies and their environmental and North Macedonia at a coupon rate of sustainability. At the EU-Western Balkans 1.625 percent. Consequently, yields on the Summit in Tirana in December 2022, the outstanding Eurobonds of the Western Balkans European Commission put forward an Energy countries are elevated, although on average Support Package of EUR1 billion budget lower than half a year before (Table 5.1). At support for the Western Balkans. the same time, spreads with yields on German bonds have narrowed since the beginning of the year. 22 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation TOWARD SUSTAINABLE GROWTH Table 5.1. Yields on Western Balkans countries outstanding Eurobonds Yield in % Yield in % Spreads Coupon Maturity (28 Mar 2023) (26 Sep 2023) (basis points) Albania 3.5 16/06/2027 6.5 5.5 273.2 3.5 09/10/2025 6.1 5.5 213.0 Montenegro 2.785 16/12/2027 8.4 6.8 405.8 3.375 21/04/2025 7.3 5.9 249.8 North Macedonia 6.96 13/03/2027 – 6.0 319.4 2.75 18/01/2025 6.4 6.0 258.0 Serbia 3.125 15/05/2027 5.8 6.2 341.8 6.25 26/05/2028 – 6.8 413.2 Bosnia and Herzegovina, 4.75 01/01/2026 7.0 7.1 408.2 Republic of Srpska Source: https://www.boerse-frankfurt.de/en, accessed on 26 September 2023. Note: Spreads refer to spreads with yields on German bonds with the same or similar residual maturity. 5. High financing costs and fleeting revenue growth call for structural fiscal consolidation 23 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 6. Inflation is easing, but price pressures persist Global inflation is gradually declining of slowing economic activity, favorable supported by easing commodity price winter weather, and a global reallocation of pressures. However, both headline and core commodity trade flows. On the energy front, inflation remain elevated and above target in prices were 20 percent lower in Q1 2023 many inflation-targeting economies. Following than in Q4 2022. Despite recent energy price a peak of 9.4 percent in July 2022, global median volatility, by August 2023, the Brent oil and headline inflation declined to 4.8 in July 2023 the Europe natural gas prices were below their (Figure 6.1). The deceleration largely reflects 2022 peaks by 28 and 70 percent, respectively. favorable base effects from 2022 peaks along with a contraction in fuel and energy prices. The drivers of inflation are changing. Recent Core inflation has, on average, declined more trends suggest that, on average, external gradually reaching 5 percent in July 2023 but sources of inflation are easing, while domestic remains heightened in both AEs and emerging factors are taking a more prominent role in market and developing economies (EMDEs). driving inflation. With supply chain pressures In the euro area, inflation decelerated to easing and international commodity prices 5.3 percent in July 2023, with energy prices declining, domestic pressure stemming from declining (-6.1 percent) and food inflation excess demand, lagged effects of crisis support remaining above 10 percent (Figure 6.2). measures, corporate profits remaining high and Global commodity prices fell by 14 percent indexation of wages, appear to be a key driver during Q1 2023 and, by the end of March, of continuing high inflation in many countries they were roughly 30 percent below their (see Box 6.1). At the same time, the sharp historic peak in June 2022.8 The surge in prices tightening of monetary policy and financing that followed Russia’s invasion of Ukraine conditions has also played an important factor has largely been unwound on a combination in bringing down inflation. Despite the easing Figure 6.1. Inflation is decelerating, but Figure 6.2. Domestic food price inflation price pressures remain elevated remains high around the world Median headline global inflation Monthly food price indexes based on US$ 10 180 8 160 140 6 120 4 100 2 80 0 60 20 0 21 1 22 19 9 2 23 3 Ap -19 Ju 19 Oc l-19 Ja t-19 Ap -20 Ju 20 Oc l-20 Ja -20 Ap -21 Ju 21 Oc l-21 Ja -21 Ap -22 Ju 22 Oc l-22 Ja -22 Ap -23 Ju 23 3 l-2 l-2 l-2 l-1 l-2 l-2 n- n- n- n- n- r- r- r- r- r- t n n Ju Ju t n n Ju Ju t n Ju Ja Ja Ja Ja Ja Ja ▬ Global ▬ Average 2015–2019 ▬ Oils ▬ Grains ▬ Other food Source: World Bank Global Economic Prospects, 2023. Source: World Bank Commodity Price Data. 8 World Bank Commodity Market Outlook, 2023. 24 6. Inflation is easing, but price pressures persist TOWARD SUSTAINABLE GROWTH of several commodity prices, domestic food average10 and are a key determinant of inflation price inflation remains high around the world. in the WB6 (Figure 6.4). While consumer Information from May 2023 shows high food price inflation is easing at the regional level, inflation in many low and middle-income there is significant country-level heterogeneity. countries, with inflation higher than 5 percent By July 2023, consumer price inflation stood in 63.2 percent of low-income countries, below 5 percent in Albania (4.1 percent), 79.5 percent of lower middle-income countries, BiH (4.0 percent) and Kosovo (2.4 percent), and 67.0 percent of upper middle-income while it remains above 5 percent in Serbia countries, and many experiencing double-digit (12.5), Montenegro (6.9 percent) and North inflation.9 Elevated food prices contribute to Macedonia (8.4 percent). higher food insecurity, with severe implications for poorer populations in many developing Core inflation momentum remains high economies. pointing to persistent and broad-based price pressures. Core inflation in WB6 peaked at Inflation pressures in the WB6 region are 9.6 percent in February 2023 and has been easing, although price pressures persist. decelerating since then. However, as of July After peaking in October 2022 at 15 percent, 2023, it remains above 5 percent partly owing average consumer price inflation for the to the persistent impact of past commodity WB6 region has been on a downward trend price increases on economy-wide prices.11 By reaching 8.4 percent in July 2023 (Figure July 2023, core inflation stood at 9.4 percent in 6.3). Significant contributors to consumer Serbia and Montenegro, 7.9 percent in North price inflation have been the deceleration in Macedonia and 3.4 percent in Kosovo. Its international commodity prices, including persistence reflects, depending on the economy food prices which represent a larger share of the considered, strong domestic demand, the CPI basket in WB6 economies than the EU strength of the labor markets and wage growth, Figure 6.3. After peaking in 2022, inflation Figure 6.4. …supported by easing in the WB6 has been on a downward commodity prices trend… Consumer price inflation Energy and food consumer inflation 20 25 15 20 10 15 5 10 0 5 -5 0 No -19 Fe -19 M -20 Au -20 No -20 Fe 20 M -21 Au -21 No -21 Fe -21 M 22 Au -22 No -22 Fe -22 M -23 3 M -19 Ju 20 Se 20 De 20 M 20 Ju 21 Se 21 De 21 M -21 Ju 22 Se 22 De 22 M -22 Ju 23 23 -2 - n- p- b- - n- p- - n- v- - n- p- c- c ay g c g b v ar v c ay g ay v ar b ar ay g b ar De Au ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB ▬ WB6 … EU27 J Energy CPI inflation J Food CPI inflation ▬ CPI inflation Source: Statistical offices; World Bank staff. Source: Statistical offices; World Bank staff. 9 World Bank Food Security Update, July 2023. 10 The simple average of the weight of food in the CPI basket for the region is around 42 percent (IMF, 2023). 11 A recent IMF paper documents empirically that besides being a key driver of headline inflation, international food prices in the WB6 directly affect core inflation measures. 6. Inflation is easing, but price pressures persist 25 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 a high pass-through of past shocks to headline rate remained stable, the real exchange rate inflation into core inflation, and the lagged appreciated by 4.4 percent. In Albania, the effects of crisis response programs. currency appreciation aided a faster convergence of inflation to the target and, on account of In countries with independent monetary further domestic currency appreciation, the policy, authorities increased monetary policy central bank’s policy rate stood at 3 percent key rates throughout H1 2023(Figures 6.5 since March 2023. In North Macedonia, the and 6.6). On one hand, inflation targeting key policy rate stood at 6.15 percent in August, countries experienced inflation well above up from 1.25 percent from spring 2022. The their targets. On the other hand, exchange pegged exchange rate has remained stable and rate considerations, including the strength of foreign exchange reserves have recovered from pass-through, the trends and competitiveness losses incurred largely at the outbreak of the war concerns, impacted differently the magnitude in Ukraine, standing at more than four months of tightening by central banks in the region. of imports in June 2023. Monetary conditions In Serbia, after 16 months of continuous are still accommodative, as real policy rates gradual increases, the policy rate was eventually remain negative, reflecting rising inflation and kept unchanged in August 2023 at the level inflation expectations. of 6.5 percent. While the nominal exchange Figure 6.5. Policy rates increased Figure 6.6. Exchange rates were stable reflecting persistent inflation, but real in North Macedonia and Serbia but policy rates remain negative appreciated in Albania Percent Exchange rate annual changes, percent 6 2 5 0 4 -2 3 -4 2 -6 1 -8 0 -10 Se -19 De -19 M -19 Ju -20 Se -20 De -20 M -20 Ju -21 Se -21 De -21 M -21 Ju -22 Se -22 De -22 M -22 Ju -23 23 Ap -19 Ju 9 Oc 19 Ja -19 Ap 20 Ju 20 Oc 20 Ja 20 Ap -21 Ju 21 Oc 21 Ja 21 Ap -22 Ju 22 Oc 22 22 1 n- r- l- t- r- l- r- l- t- n- r- l- t- c c ar n p n p c ar n p ar c t n n ar n p n Ju Ja ▬ ALB ▬ MKD ▬ SRB ▬ Eurozone ▬ ALB ▬ MKD ▬ SRB Source: Central banks; World Bank staff. Source: Central banks; World Bank staff. 26 6. Inflation is easing, but price pressures persist TOWARD SUSTAINABLE GROWTH Box 6.1. Inflation drivers in the Western Balkans since 2021: profits, then wages The inflation drivers over the past two years have been in the focus of debates across the EU countries and the Western Balkans. The analysis of the inflation drivers for the Western Balkans follows the recent approach of the ECB12 and IMF13 to decompose GDP deflator growth, used as a proxy for inflation, into a weighted sum of unit labor cost (additionally split into wages and productivity), unit profits, and unit taxes, all measured as per unit of real GDP.14 Since no Western Balkan country publishes timely, high-frequency GDP income approach data (only yearly data exist for BiH and Montenegro), this analysis relies on proxies.15 The total compensation of employees is estimated by multiplying the number of employees by the average gross wage, plus a markup for employers' social contributions, while profits, precisely gross-operating surplus and mixed income, are calculated as the difference between gross value added and labor cost. Net taxes on production are taken from the GDP production approach data. Despite relying on proxies due to data availability limitations, the results of the methodology appear to be robust. Comparisons of yearly aggregated proxy outcomes with those of published GDP income approach data confirmed the findings for BiH and Montenegro. The analysis shows that, while profit growth was an important driver of inflation in 2021 and in H1 2022 in several Western Balkan countries, labor costs have been the inflation driver since H2 2022. Similar to EU countries, profits’ contribution to inflation in the WB6 began to rise already one year before the war in Ukraine, in the middle of the COVID-19 pandemic. Limits to short-term supply elasticities meant that the recovery in demand enabled firms to increase profit margins in those sectors exhibiting supply-demand mismatches. As the supply capacity improved over time and demand patterns normalized, a decline in profit margins translated into lower inflationary pressures.16 However, with the beginning of the cost-of-living crisis in 2022, wage pressures strengthened. Profits became the largest driver of domestic inflation in 2021 in Albania, BiH, and Montenegro, and in 2022 in North Macedonia, while wage growth primarily drove inflation in Serbia and Montenegro from early 2022, and in North Macedonia and BiH from late 2022, as minimum wages and labor demand increased. In Albania, profits grew from mid-2021, contributing on average 2.6 percentage points to inflation in that year, and showed exceptional growth in 2022, pushing inflation up by 7.7 percent. As the share of 12 https://www.ecb.europa.eu/press/blog/date/2023/html/ecb.blog.230330~00e522ecb5.en.html 13 Hansen, Toscani, Zhou (2023): Euro Area Inflation after the Pandemic and Energy Shock: Import Prices, Profits and Wages. IMF Working Paper. WP/23/131. 14 The weights are determined by each unit cost’s share in real GDP. To analyze the effect of wages on inflation, unit labor cost growth is split up into wage growth and labor productivity growth, assuming equal weights. 15 There are no published data on quarterly gross wages in Kosovo, hence Kosovo is excluded from the analysis. Changes in labor force survey methodologies in North Macedonia, BiH and Montenegro proved to be an obstacle to getting consistent employment statistics: (i) the 2022’s employment in North Macedonia was estimated by applying employment rate growth to historical employment data before the revision; (ii) in BiH, since the adjustment was stepwise, only data from Q2 2020, after the completed adjustment, are used; and (iii) Montenegro LFS employment showed large volatile fluctuations, hence administrative employment data are used. 16 https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230306~57f17143da.en.html 6. Inflation is easing, but price pressures persist 27 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 (Box 6.1 continued) the self-employed who earn mixed income that counts toward profits is high in Albania, profits have a larger weight in inflation. On the other hand, lower contribution of wages (also due to informality) also limits the pass through from a minimum wage increase. In Bosnia and Herzegovina, profits were the main driver of inflation in 2021 and remained strong throughout 2022, contributing around 5.3 percentage points to inflation. A gradual increase in gross nominal wages raised their contribution to inflation from 2022 and took over as the main inflation driver in H2 2022. In North Macedonia, the role of profits in driving inflation remained relatively low in 2021, with an average contribution of around 0.7 of a percentage point. However, in 2022, they contributed 5.7 percentage points to inflation, although the wage contribution became slightly larger than that of profits in H2 2022. In Montenegro, profits pushed inflation up on average by 3.7 percentage points in 2021, but in 2022 this trend was interrupted by the increase in employment and minimum wage, which pushed up labor costs. Since then, wages have become a main contributor to inflation, yet profit growth has started increasing again in H2 2022. Finally, net taxes also contributed to a rise in inflation in 2022, except in North Macedonia. In 2022, net taxes in North Macedonia lowered inflation by 5 percentage points. This was due to a sharp rise in subsidies on products that was larger than the rise in indirect taxes, thus turning the unit tax contribution to inflation growth negative. This has changed in 2023 as the Government of North Macedonia reduced subsidies to the economy. In other countries, net taxes have had small, albeit noticeable upward pressure on GDP deflator growth since 2021. Inflationary pressures are subsiding across the Western Balkans but vigilance is needed to lower the alleviated price levels. On one side, supply side pressures lowered, due to decline in energy inflation and some signs of deceleration of food inflation. Also, demand started weakening in several countries in 2023 as high inflation started eroding real incomes. However, core inflation has not declined, and inflation expectations are high. In order to maintain a declining trend, it will be important to ensure synchronization of monetary policy tightening with tighter fiscal policy and avoid fueling inflation through wage increases. On the structural front, strengthening the competition policy to avoid oligopolies, and reducing market entry and conduct barriers in retail and non-tradables, as well as network industries, will help to alleviate the price pressures over the medium to longer term. 28 6. Inflation is easing, but price pressures persist TOWARD SUSTAINABLE GROWTH (Box 6.1 continued) Figure 6.7. Drivers of inflation (GDP deflator income approach) Annual percentage changes, weighted percentage point contributions Albania Bosnia and Herzegovina 12 20 10 15 8 10 6 4 5 2 0 0 -5 -2 -4 -10 1 1 1 1 2 2 2 2 3 1 1 1 2 2 2 2 3 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 Q1 Q2 Q4 Q2 Q4 Q3 Q3 Q1 Q2 Q4 Q1 Q2 Q4 Q3 Q1 Q3 Q1 Montenegro North Macedonia 20 20 15 15 10 10 5 5 0 0 -5 -10 -5 -15 -10 1 1 1 1 2 2 2 2 3 1 1 1 1 2 2 2 2 3 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 Q1 Q2 Q4 Q1 Q2 Q4 Q3 Q3 Q1 Q2 Q4 Q1 Q2 Q4 Q3 Q1 Q3 Q1 Serbia 20 15 10 5 0 -5 -10 1 1 1 1 2 2 2 2 3 3 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 Q1 Q2 Q4 Q3 Q1 Q2 Q4 Q3 Q1 Q2 J Labor productivity J Wages J Unit profits J Unit net takes ▬ GDP deflator Q Unit labor cost Sources: Statistical offices; World Bank staff. Note: Labor productivity affects inflation negatively because it reduces labor costs. 6. Inflation is easing, but price pressures persist 29 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 7. The financial sector remains stable while the outlook is fragile The financial sector in the Western Balkans may have spillover effects on the banking has remained stable and resilient despite the sector. Tighter financial conditions are continuation of multiple challenges testing affected by various factors, including the war financial stability posed by the ongoing in Ukraine, higher inflation, higher interest war in Ukraine and weak economic growth rates, and the slowdown of economies. Average prospects, as well as the surge in interest credit growth in the Western Balkans had rates and inflation. Non-performing loans already flattened by June 2022 before starting (NPLs) continued to follow a downward trend, to slow down since October 2022. Although declining to a historical low (3.9 percent), while still positive, credit growth decelerated to profitability exceeded pre-pandemic levels 5.7 percent as of June 2023, almost half of its and capital buffers were preserved. Current peak in June 2022 (10.4 percent) in the post- financial sector performance demonstrates the pandemic period. The largest declines in credit strong resilience of the sector thanks to the growth as of June 2023 compared with June robust financial position of banks achieved by 2022 were in Serbia and Albania (credit growth decisive reforms and restructuring over the past fell to 1.5 and 1.6 percent, respectively), while decade (following the global financial crisis) growth remained strong in Kosovo and flat and strong support from governments during in BiH (Figure 7.1). Corporate loan growth the COVID-19 pandemic. decelerated sharply in H1 2023, faster than household loan growth, indicating that banks In H1 2023, credit growth continued to tightened standards more for small and medium decline with the expectations of deteriorating enterprises (SMEs) and corporate clients (Figure credit supply conditions, testing corporate 7.2). SMEs may be particularly vulnerable to and household resilience as a result, which tightening credit supply conditions, higher Figure 7.1. Credit growth was slashed by Figure 7.2. Corporate loans experienced half compared with a year ago a sharp slowdown and even shrunk in Albania, BiH and Serbia Change in nonfinancial private sector credit outstanding, percent, Change in credit outstanding, July 2023, percent, yoy yoy 20 20 15 15 10 10 5 5 0 0 -5 Ju 6 Ja 16 Ju 7 Ja 17 Ju 8 Ja 18 Ju 9 Ja 19 Ju 0 Ja 0 Ju 1 Ja 21 Ju 2 Ja 22 Ju 3 3 -5 2 1 2 2 l-2 1 1 1 2 l-2 n- l- n- l- n- l- n- l- n- l- n- l- n- n- Ja ALB BiH KOS MKD MNE SRB ▬ ALB ▬ BiH ▬ MKD ▬ MNE ▬ SRB ▬ KOS J Firms J Households Sources: IMF International Financial Statistics; central banks. Source: Central banks. 30 7. The financial sector remains stable while the outlook is fragile TOWARD SUSTAINABLE GROWTH financing costs and a slowdown in economic cross-border banking groups do not foresee a activity, while households’ real incomes and significant deleveraging or strategic change in consumption remain under pressure from the region. Positive funding conditions driven persistently high inflation. by corporate and retail deposits are expected to continue in H2 2023. Gradually weakening credit demand is expected to narrow the mismatch between The regional average NPL ratio continued credit demand and supply in H2 2023. to decline, recording a historical low value, According to the results of the latest Central, while asset quality concerns remain given Eastern and Southeastern Europe (CESEE) the weakening economic outlook ( Figure Bank Lending Survey,17 after gradually 7.3). The regional average NPL ratio decreased weakening since 2021, credit demand stabilized by 0.4 of a percentage point from June 2022 and remained healthy during the first months of to 3.9 percent in June 2023. NPL ratios are 2023. Corporate liquidity needs for inventories higher than the region’s average in Montenegro and, in particular, working capital are expected (6.1 percent), Albania (5.2 percent) and BiH to be the main drivers of demand, while fixed (4.1 percent). All countries recorded declining investments and retail segments are expected or stable NPLs compared with their June 2022 to contribute negatively. On the supply side, levels, while Kosovo’s NPLs remained the credit supply conditions are expected to lowest in the region (2 percent). deteriorate further over H2 2023 as a result of increased uncertainty, a worsening economic Asset quality resilience remains under outlook, and increased costs of financing. stress, due to persistent macroeconomic All business segments have been similarly pressures, including high inflation and affected, especially regarding longer tenor interest rates, combined with low economic lending. While banks continue their selective growth prospects in many jurisdictions, approach in search of creditworthy customers, as well as remaining vulnerabilities in the Figure 7.3. NPLs continued a downward Figure 7.4. Gap between Stage 3 and trend 2 loans is increasing, an indication of forward-looking recognition of potential loan impairment NPLs as percent of total loans Stage 2 and 3 loans as percent of total loans 8 14 7 12 6 10 5 8 4 6 3 4 2 1 2 0 0 MNE ALB BiH SRB MKD KOS 2018 2019 2020 2021 2022 J Jun-22 J Dec-22 J Jun-23 Q Pre-crisis level (end 2007) J Stage II and III gap ▬ Stage II ▬ Stage III Sources: IMF Financial Soundness Indicators; central banks. Sources: Fitch; World Bank staff. 17 EIB Central, Eastern and Southeastern Europe Bank Lending Survey, Spring 2023. 7. The financial sector remains stable while the outlook is fragile 31 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 post-pandemic period. The widening gap Figure 7.5. Banks’ capital buffers were preserved between stage 2 and stage 3 loans18 (Figure Percent 7.4) is clear evidence of existing and potentially 25 growing pressures on credit risk. Elevated 20 stage 2 loans—forward-looking recognition of potential loan impairment—point to a higher 15 share of loans with a significant increase in 10 credit risk. As of December 2022, the Western Balkans’ regional average for stage 2 loans was 5 at 11.82 percent, much higher than NPLs, at 0 3.9 percent. Stage 2 loans have been increasing SRB MNE BiH ALB MKD KOS J Jun-22 J Dec-22 J Jun-23 Q Average (2006–08) consistently in the post-pandemic environment Sources: IMF Financial Soundness Indicators; central banks. and, as of December 2022, are 4.73 percent above their end-2019 level (pre-pandemic Higher interest rates helped boost banks’ period). The CESEE Bank Lending Survey also lending margin and profitability. Profitability indicates that, given the unfavorable economic as measured by return on assets has increased to outlook, banks still expect an increase in NPLs 2.3 percent in June 2023 from 1.6 percent a during 202319 consistent with their stage 2 loan year ago, supported mainly by the rising interest portfolios. rates. As of June 2023, Kosovo and Serbia had the highest profitability (2.6 percent), while Capital buffers in the Western Balkan Albania had the lowest (1.8 percent). Going countries remained broadly stable, while forward, it will be important to monitor bank liquidity is slightly lower compared with profitability, considering the risks for the December 2022. As of June 2023, the bank outlook. A weaker economy and increased capital adequacy ratio averaged 19.1 percent, credit risk may weigh on bank profitability far above the regulatory minimum, and prospects in the medium term by increasing higher compared with December 2022, at provisioning and impairment cost. 18.3 percent (Figure 7.5). The ratio of liquid to total assets averaged 28.7 percent in June 2023, However, despite the demonstrated recovering from its lowest level in June 2022, resilience, the financial stability outlook potentially reflecting slowing loan growth in continues to remain fragile amid weak macro- recent months. Loan-to-deposit ratios were financial conditions. The outlook in the WB6 well below 100 across the board (76.4 percent region remains uncertain, given the presence on average in June 2023), indicating slower of downside risks to growth accompanied by loan growth than deposit growth. persistent inflationary pressures. The high- interest environment, which is now expected to last longer than previously anticipated, is triggering asset repricing, changing investor 18 Stage 2 Assets, in the context of International Financial Reporting Standard (IFRS) 9, are financial instruments that have deteriorated significantly in credit quality since initial recognition but that offer no objective evidence of a credit loss event. Assets are classified Stage 3 if the loan’s credit risk increases to the point where it is considered credit impaired. The IFRS is published by the International Accounting Standards Board. IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy and sell nonfinancial items. 19 Central, Eastern and Southeastern Europe (CESEE) Bank Lending Survey, Spring 2023. 32 7. The financial sector remains stable while the outlook is fragile TOWARD SUSTAINABLE GROWTH sentiment, and asset allocations. In such an financial sector, they should also continue environment, remaining vulnerabilities can reforms to enhance the financial sector’s role easily create stress, as was seen in the banking in growth and development. The financial sectors of some mature economies. sector plays a key role in allocating resources efficiently, operating payment systems—a Banks and regulators should have a key element of a country's economic and comprehensive understanding of potential financial activity—and helping to manage pressure points in the lending books, which risks and provide long-term funding for critical includes having clear and implementable investments. Countries in the WB6 region plans for different credit or liquidity have been embarking on reforms to harmonize risk deterioration scenarios. Credit risks their frameworks with international and EU from residential and commercial real estate, standards in recent years. One of the areas that uncollateralized consumer finance, interest rate has achieved significant progress is in digital sensitive portfolios, and sovereign exposures payments. All the countries in the region are in must all be monitored closely. As banks are the process of adopting EU payment laws and expected to continue tightening financial regulations. However, there is more to be done conditions and credit standards, highly to complete this harmonization, as well as to indebted households and corporates may come build capacity and infrastructure. As the central under stress. nervous system of the economy, modernized payment systems could help WB6 economies Financial stability is paramount for the boost businesses efficiency, facilitate trade financial sector to play its fundamental roles and investment, address informality, enhance in growth and development. While authorities financial inclusion and facilitate remittances, need to keep their focus on monitoring any which represent a significant share in WB6 remaining pockets of vulnerability in the countries’ GDPs (see Box 7.1). Box 7.1. Digitalization through modernization of Western Balkans’ payment systems Digital payments have become more prevalent in the Western Balkans, though there still remains more to be done. As economies become more digital, payments—particularly digital payments—enable this transition. They allow economic and financial activities to occur at a faster, more convenient, and safer rate. The usage rate of digital payments—transferring payments through a digital payment instrument, device or channel such as electronic bank transfers, credit and debits cards, electronic money (e-money), QR codes—has been increasing across the Western Balkans over the past few years, driven by regulatory reforms and market initiatives (Figure 7.6). The digitalization of payments is particularly pertinent to the Western Balkan countries, both for domestic and cross-border payments/transfers in their efforts to align with EU standards. Domestically, digital payments support businesses to operate 7. The financial sector remains stable while the outlook is fragile 33 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 (Box 7.1 continued) more efficiently and safely with less cash. Figure 7.6. Western Balkans: Digital Furthermore, they help reduce the informal Payments economy and increase transparency, support Made or received a digital payment financial inclusion efforts by closing the Percent 100 of 15+ years old urban and rural divide and, finally, support 87 broader fintech development. For example, 80 74 increasing digital payments by 10 percent 60 67 60 66 66 (by means of converting payments from 40 48 50 cash to digital) would reduce acceptance cost 35 39 29 and is projected to decrease the informal 20 economy by 2 percent.20 Cross-border 0 ALB KOS BiH MNE MKD SRB digital payments support remittance flows J 2017 J 2021 by lowering transaction costs and enabling Source: World Bank Global Findex 2017, 2021. Note: Data were not included for Montenegro in the 2021 Global deeper intra-regional and EU integration for Findex Survey. the Western Balkan economies. There is a large diaspora of Western Balkan citizens abroad with nearly 20 percent of the WB6 population residing abroad, generating a substantial flow of remittances, equivalent to 10 percent of GDP in the WB621 (see also Section 8). The average cost of sending remittances to WB6 was 6.71 percent at the end of 2022 and sending remittances to WB6 countries from the EU region is 32 percent more expensive than from other regions.22 The higher remittance costs in the WB6 are driven by several factors, including: (i) not being part of regional/continental initiatives yet such as the Single European Payments Area (SEPA); (ii) the lack of innovative payment service providers in the domestic markets (though it is changing with the transposition of the EU Payment Systems Directive 2); (iii) the lack of interoperable instant payments infrastructures that could also facilitate cross-border payment linkages; and (iv) limited financial literacy and overall cash culture. If there were a 3-percentage-point reduction in the cost of sending remittances, this could bring estimated savings of EUR 0.5 billion for end users.23 Given the importance of digital payments, the Western Balkans authorities have prioritized efforts to improve the enabling environment for the underlying payments systems. The Western Balkan authorities continue their broad efforts to improve the enabling environment. This requires improving their legal and regulatory frameworks to align with the relevant EU directives and regulations, strengthening their oversight roles of their payment systems, further enhancing cybersecurity, know-your-customer (KYC) aspects, and introducing open banking, as well as implementing new generation payment infrastructures, such as fast payment systems (FPS). 20 The hidden economy in the Western Balkans in a time of crisis: Friend or foe; Southeast European Leadership for Development and Integrity (SELDI), 2022. 21 https://www.oecd.org/south-east-europe/programme/Labour-Migration-report.pdf 22 World Bank analysis and https://remittanceprices.worldbank.org/ 23 World Bank staff calculations. 34 7. The financial sector remains stable while the outlook is fragile TOWARD SUSTAINABLE GROWTH (Box 7.1 continued) In particular, FPS implementation has been viewed as a critical missing milestone for the region. FPS allow for instant transfer of funds, 24/7/365 availability of service, as well as interoperability among different types of payment service providers (banks and non- banks), thus leading to faster, more efficient, more affordable and safer domestic and cross- border digital payments. Furthermore, the region has set as a prominent objective, and is working toward, membership of the SEPA. Customers in SEPA member countries can make cashless euro payments—via credit transfer and direct debit—to anywhere within the SEPA jurisdiction just like national payments. In general, payment integration triggered by the SEPA has contributed to the efficiency and competitiveness of the European economy as a whole by eliminating differences between national and cross-border payment costs, and by harmonizing standards in all the participating countries. SEPA membership would also enable subsequently indirect access to the European TARGET Instant Payment Settlement (TIPS) system for the Western Balkans, which would allow their respective payment service providers to offer instant, seamless fund transfers on a 24/7/7365 basis. This would thereby facilitate intra-regional and EU integration of the Western Balkan economies. Policy makers in the Western Balkans should continue their efforts to modernize their payment systems by implementing the required legal reforms, as well as modernizing their payments infrastructure. Concerted efforts in both areas are a crucial step toward digitalization of their economies, as well as advancing their economic integration with the EU. This includes the achievement of SEPA membership and eventual access to TIPS. 7. The financial sector remains stable while the outlook is fragile 35 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 8. Despite elevated merchandise trade deficits, external current accounts are set to improve After a temporary spike in 2022, the average in 2023. BiH is the only country in the WB6 CAD is expected to improve in the Western where the CAD is projected to marginally Balkans over the course of 2023, even deteriorate, from 4.5 percent in 2022 to though merchandise trade deficits remain 4.7 percent in 2023. elevated  (Figure 8.1). The WB6 external account is projected to decline to 5.8 percent Food, oil, and electricity prices slowly trended of GDP in 2023, following a temporary spike downward toward the end of 2022 and in to 7.8 percent of GDP in 2022, which was H1 2023, but nonetheless the merchandise 2 percentage points higher than the previous trade deficit remains stubbornly high. Some year. This is the lowest CAD in the WB6 since pressure on the merchandise deficit has been 2006. The largest WB6 CAD in 2023 is set released with the sharp deceleration in aggregate to occur in Montenegro at 11.5 percent of demand and import prices that started trending GDP, the only country with a double-digit downward. Nevertheless, the merchandise trade external deficit in the region, while the smallest deficit in the WB624 is expected to reach close is expected in Serbia at a mere 2.5 percent of to 28.3 percent of GDP in 2023 (Figure 8.2). GDP. The most pronounced improvements This sizable shortfall, while 2 percentage points in the CAD are likely to materialize in Serbia smaller than the year before, remains more and Kosovo. In Serbia, the CAD is expected to pronounced than the merchandise trade deficits improve from 6.9 percent of GDP in 2022 to seen since 2013, including during the pandemic 2.5 percent in 2023. In Kosovo, the external year. The somewhat smaller merchandise trade deficit is expected to almost halve, from deficit in 2023 is the result of a contraction in 10.5 percent of GDP in 2022 to 6.5 percent imports (2.6 percentage points) that exceeds Figure 8.1. Current account deficits Figure 8.2. …despite continued elevated (CAD) improved in most countries in the merchandise trade deficits from a region… historical perspective Percent of GDP Percent of GDP MNE KOS ALB BiH MKD SRB WB6 -24 0 -25 -5 -10 -26 -15 -27 -20 -28 -25 -29 -30 -30 -35 -31 e 11 12 13 14 15 16 17 18 19 20 21 22 23 20 20 20 -40 20 20 20 20 20 20 20 20 20 20 J 2007 J 2009 J 2020 J 2022 J 2023e ▬ WB6 Sources: Central banks; World Bank staff estimates. Sources: Central banks; World Bank staff estimates. Note: WB6 is simple average of WB6 CADs. Note: WB6 is simple average of WB6 CADs. 24 Exports and imports of goods, simple average of the six countries. 36 8. Despite elevated merchandise trade deficits, external current accounts are set to improve TOWARD SUSTAINABLE GROWTH the contraction in exports (0.7 of a percentage Net services and remittances play an point). This contraction in imports of goods increasing role in mitigating structural is largely driven by Serbia (7.3 percentage merchandise trade deficits ( Figures 8.3 points), Kosovo (3.9 percentage points), and and 8.4). In 2023, net services exports and Albania (3.5 percentage points) as the value remittances are projected to average 19.0 percent of imported fuels dropped. In Albania, for of GDP, demonstrating a consistent upward example, the fall in the value of imported fuels, trend in GDP terms since 2014 when these net mainly from Algeria, was accompanied by a inflows accounted for 13.5 percent of GDP.25 decline in the value of imported construction Visits by workers residing abroad contribute materials and metals, which together more most to travel inflows in BiH, Kosovo, and than offset higher imports of machinery and North Macedonia, whereas Albania and other equipment. Meanwhile, the marginal Montenegro have a more prominent tourism decline in exports of goods was a combination sector. It is worth noting that BiH has been of a reduction observed in the range between steadily increasing its tourism revenues, with 0.2 and 1.7 percentage points in North overnight stays from Croatia, Serbia, Türkiye, Macedonia, Montenegro, Albania, Serbia, Saudi Arabia, and the United Arab Emirates and Kosovo, together with an improvement of accounting for 45 percent of the 1.4 million 1.5 percentage points in BiH. In Montenegro, overnight stays recorded during January to July for example, the surge in electricity exports 2023. This represents a 30 percent increase was more than offset by the drop in exports of compared with the previous year. Meanwhile, metals and metal ores to the EU and China. remittances in the WB6 have been recovering The export of goods is set to barely change in since hitting a low in 2016 and have surged North Macedonia, with a decline of 0.2 of a since 2021 (Figure 8.4). While this is not percentage point in 2023 compared with 2022. immediately obvious from levels expressed in GDP terms, it is worth bearing in mind that growth in the denominator (nominal GDP) Figure 8.3. Services and remittances Figure 8.4. …and exhibit a continuous across the WB6 help contain external increase compared with pre-pandemic deficit… years Contributions to changes in CAD in 2023e, percent of GDP Percent of GDP, WB6 simple average 4 20 2 15 0 10 -2 -4 5 -6 0 e -8 10 11 12 13 14 15 16 17 18 19 20 21 22 23 20 20 20 20 20 20 20 20 20 20 20 20 SRB KOS MKD MNE ALB BiH 20 20 J Goods exports J Goods imports J Net services exports J Net services exports J Remittances J Remittances J Others Q Change in CA deficit Sources: Central banks; World Bank staff estimates. Sources: Central banks; World Bank staff estimates. 25 With the exception of 2020, the pandemic year. 8. Despite elevated merchandise trade deficits, external current accounts are set to improve 37 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 has been in the double digits in most countries automotive industry. In BiH and Montenegro, in the region from 2021 to 2023 due to net FDI inflows primarily consist of non- extraordinarily high inflation rates. Specifically, debt creating flows in the form of equity and in 2023, remittances are expected to remain reinvested earnings. It is expected that BiH robust at 6.9 percent of GDP, only 0.1 of a and Montenegro will finance about 71 and percentage point less than the level recorded 52 percent of their CADs, respectively (Figure in 2022, when remittances reached a historical 8.6). This is a large shift for Montenegro, which peak over the past two decades. During these is estimated to experience a significant decline two years (2022 and 2023), nominal GDP grew in net FDI inflows of about 5 percentage points. on average 11.9 and 11.2 percent, respectively, across the WB6 compared with an average Total external debt in the Western Balkans growth rate of only 4.4 percent in 2019. region is showing a downward trend, with a projected average of 73 percent of GDP, Net FDI inflows, on average, continue to from its peak at close to 90 percent of GDP finance the external imbalance in the WB6. in 2020. This decline in external debt can be Since 2021, net FDI inflows have continued attributed to reductions in both public and to play a crucial role in funding CADs in private debt, with both sectors witnessing a the Western Balkans (Figure 8.5). In 2023, reduction of about 8 percentage points since Albania, Kosovo, and Serbia are expected to 2020. Continued foreign net inflows exceeding experience significant net FDI inflows estimated the borrowing requirement have supported the at over 6 percent of GDP, fully financing their buildup of foreign exchange reserves. By end- respective CADs (Figure 8.6). In Serbia and September 2023, foreign exchange reserves North Macedonia, intercompany loans—a remained strong for the region and prudent debt-creating FDI flow—dominate, as these adequacy levels were maintained for all WB6 countries continue integrating into EU-centric countries. manufacturing value chains, in particular in the Figure 8.5. Net FDI inflows have almost Figure 8.6. …although on a country basis entirely financed the external deficit over the extent to which CADs are financed by the past three years… FDI inflows varies significantly Contributions to changes in CAD, percent of GDP Percent of GDP, 2023e 22 14 20 12 18 16 10 14 8 12 6 10 8 4 6 2 4 e 0 23 10 20 1 20 2 20 3 20 4 20 5 16 20 7 18 20 9 20 7 08 20 9 20 20 1 22 1 2 1 0 1 1 1 1 1 0 20 20 20 20 20 MNE ALB KOS SRB MKD BiH WB6 20 20 ▬ Net FDI inflow ▬ CAD J CAD J Net FDI Sources: Central banks; World Bank staff estimates. Sources: Central banks; World Bank staff estimates. 38 8. Despite elevated merchandise trade deficits, external current accounts are set to improve TOWARD SUSTAINABLE GROWTH 9. Reforms are needed to consolidate the recovery and move toward sustainable growth Global and regional economies are set to suggests that monetary tightening is expected recover in 2024. As the WB6 countries are to continue. open economies, their economic performance is dependent on the performance of the rest Growth is expected to decelerate across of the world. The WB6 are integrated into the WB6 countries in 2023 and then to the global economy mainly through the trade gradually recover over the medium term route, and with the EU and ECA through (Figure 9.1). After the strong post-COVID-19  exports, remittances and FDI inflows. Growth recovery in 2021, growth decreased in 2022 in in the global economy, the EU and ECA is part due to base effects and due to the impact expected to bottom out in 2023 and to recover of Russia’s invasion of Ukraine. In 2023, in 2024. Since June, output for both the global slower growth in the WB6 is primarily due to economy and ECA has been revised slightly weaker consumption and exports, reflecting upward for 2023, with better performance weaker EU performance, including weaker in ECA driven by the Russian Federation, EU imports for industrial goods. While GDP Türkiye, and Ukraine, despite the continuation growth is expected to recover in 2024 and of Russia’s invasion of Ukraine. Output for 2025 and return to trend, as inflation subsides the EU has instead been revised downward, and real incomes increase, there are differences attesting to the fragility of the recovery (see across countries. Serbia, North Macedonia and Box 9.1). For all three groupings, growth is to some extent BiH and Kosovo are expected expected to be below the pre-pandemic five- to accelerate growth in 2024 and beyond. On year average,26 suggesting that the recovery is the other hand, Albania and Montenegro are still weak, while the persistence of inflation Figure 9.1. GDP growth is expected to Figure 9.2. All WB6 countries are decelerate in 2023 and gradually recover expecting to bring inflation closer to their over the medium-term medium-term targets GDP growth Inflation, pa 7 16 6 14 12 5 10 4 8 3 6 2 4 1 2 0 0 ALB BiH KOS MKD MNE SRB WB6 ALB BiH KOS MKD MNE SRB WB6 J 2015–19 average J 2022 J 2023e J 2024f J 2025f J 2015–19 average J 2022 J 2023e J 2024f J 2025f Source: World Bank staff. Source: World Bank staff. 26 Average annual GDP growth rates for the world, the EU and ECA during 2015–19 were 3.0, 2.4, and 2.1 percent, respectively. 9. Reforms are needed to consolidate the recovery and move toward sustainable growth 39 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 expected to observe decreasing rates of growth strengthen their fiscal balances and to offset over the next couple of years. some of the expenditures increases. All WB6 countries are expecting to bring Public debt is on sustainable paths, based inflation closer to their medium-term targets, on low fiscal deficits, although downside which should help strengthen disposable risks can easily reverse the trend. All WB6 income and support the consumption side countries are projecting a decrease in fiscal of growth  (Figure 9.2). The WB6 countries, deficits over the medium term. Kosovo and except Albania, faced double-digit inflation in Montenegro expect a one-off increase in its 2022, including food and energy price surges, deficit in 2024 and then to return to a declining which resulted from the measures taken during path. As a result, public debt is expected to the pandemic and the supply shortages that be on a declining path and to be sustainable. followed and by Russia’s invasion of Ukraine. The average share of public debt in GDP is Inflation is on a downward trend in the region, projected to fall from 50.6 percent at the end though for three of the countries (Montenegro, of 2022 to 47.9 percent in 2025. Risks similar North Macedonia and Serbia) in 2023, it is still to those of the growth outlook (i.e., natural expected to be more than half the 2022 rates. disasters and SOE performance) could pose Core inflation also remains high, suggesting risks to the baseline fiscal projections. sticky and broad-based price pressures. At the same time, strong labor markets and Numerous uncertainties are expected to wage growth may weigh further on inflation, have a differing impact on the external in the absence of supply responses. In this account of the WB6. On average, the trend context, while efforts to combat inflation have is toward deterioration. Pressure from domestic yielded good results through 2022, monetary consumption (and capital expenditures for authorities are expected to remain vigilant to some countries) on the one hand and weakened meet their medium-term targets. EU growth prospects on the other, are expected to have a negative effect on the external account. Fiscal balances are expected to improve in This may be compounded by stubbornly high 2023 for Albania, Montenegro and Serbia, food prices and the impact of energy insecurity to remain unchanged for North Macedonia, should downside risks materialize. Importantly, while to deteriorate for the other Western the region has historically relied on Russian Balkans. BiH’s fiscal balance is expected to energy supplies, making it susceptible to deteriorate in 2023 owing to the municipal disruptions in energy transit routes and price elections to be held later in the year. These fluctuations caused by disruptions in supply elections are expected to erode some of the chains. At the same time, the presence of 2022 deficit gains. In 2024, Kosovo and political tensions in the region contributes to Montenegro are expected to push ahead with a heightened risk premium in the countries, large-scale infrastructure projects, which will acting as a deterrent to attracting even greater adversely affect their fiscal positions that levels of foreign investment. Financing for the year. However, most of the WB6 countries current accounts is expected from FDI and are expected to adopt revenue measures to external borrowing. Overall external debt for 40 9. Reforms are needed to consolidate the recovery and move toward sustainable growth TOWARD SUSTAINABLE GROWTH the WB6 countries is high, yet declining, with and energy efficiency. Other reforms aimed the external debt-to-GDP ratio expected to at increasing market competition, attracting reach 73.1 percent of GDP in 2023. higher-quality investments, and addressing barriers that limit labor force participation Risks to the growth outlook remain tilted to (especially among women) or attracting the downside. A prolonged slowdown in the workers, also hold the potential to boost EU, as well as internal structural bottlenecks, economic growth in the region. Accelerating could lead to even further downward revisions regional integration would also help accelerate to growth projections. In addition, if inflation convergence. rates are not brought back to long-term averages as planned, this may further hurt the domestic Negotiations with the EU hold the potential demand, which is usually one of the key drivers to bolster prospects in the Western Balkans. of growth in the WB6 region. Finally, in some While the pace of these negotiations has been countries (Albania and Serbia, in particular) slow, there is an opportunity to mitigate the natural disasters could pose a significant geopolitical spillover effect from the war in risk to the growth outlook by impacting the Ukraine through a renewed push for EU agriculture and energy sectors. integration in the region. The recent summit in Bled, Slovenia, has discussed prospects for Reforms are needed to consolidate the an acceleration in the EU accession process recovery toward sustainable growth. The with an aspirational timeline to join the EU by ongoing energy crisis has highlighted the need 2030. This presents a significant opportunity to accelerate the green transition across Europe, for the region's external accounts and economic including in the Western Balkans, and with a prosperity in general, although in the case focus on key sectors, such as agriculture (see of some countries with more pronounced Spotlight). The crisis has also highlighted the political risks, a shortened timeline may be importance of promoting diversification of advantageous. energy sources, moving toward renewables, Box 9.1. Global activity is improving but remains on thin ice Growth is expected to bottom out in 2023 and should rebound modestly. According to the last edition of Global Economic Prospects (June 2023), global growth is expected to reach only 2.1 percent this year before picking up to 2.4 percent in 2024 and 3.0 percent in 2025, below its pre-pandemic level with average between 2010 and 2019 at 3.33 percent. Growth in AEs has been more resilient than expected in H1 2023, especially in the United States. In contrast, economic prospects deteriorated for China, reflecting a slump in the real estate sector (Figure 9.3a). Global PMIs indicate a deceleration in global activity, with manufacturing remaining soft and services growth cooling. PMI readings for manufacturing new export orders, which remain in negative territory, signal continued weakness in trade (Figure 9.3b). 9. Reforms are needed to consolidate the recovery and move toward sustainable growth 41 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 (Box 9.1 continued) Figure 9.3. Global economic developments a. GDP growth forecasts b. PMI: Global and export orders Percent Percent 6 61 59 5 57 4 55 3 53 51 2 49 1 47 45 0 M -21 M r-21 Ju 21 Se l-21 No -21 Ja -21 M -22 M r-22 Ju 22 Se l-22 No -22 Ja -22 M -23 M r-23 Ju 23 Se l-23 23 2023 2024 2025 2023 2024 2025 2023 2024 2025 - - - p- ay n p v ay ay n p v n a a a Ja Euro area US China J Sep-23 Q Jun-23 ▬ Global PMI manufacturing … Export orders manufacturing ▬ Global PMI services … Export orders PMI services c. Headline inflation d. Evolution of policy interest rates Percent Percent 12 100 10 80 8 60 6 40 4 20 2 0 0 2 2 3 3 3 2 2 3 3 -2 -2 -2 -2 -2 -2 -2 -2 -2 Oc -19 Ja -19 Ap -20 Ju 20 Oc -20 Ja 20 Ap -21 Ju 21 Oc -21 Ja 21 Ap -22 Ju 22 Oc -22 Ja 22 Ap -23 Ju 23 3 Q4 Q4 Q3 Q1 Q2 Q3 Q1 Q2 Q3 l-2 r- t- r- t- r- r- t- n l l t n l n n l Ju EMDEs Advanced economies ▬ Global ▬ AEs ▬ EMDEs J Increased J Unchanged J Decreased Sources: Consensus Economies; Haver Analytics; World Bank. Notes: EMDEs = emerging market and developing economies. PMI = Purchasing Managers’ Index. a) Bars show the consensus forecast estimates for GDP growth based on surveys from September 2023. Diamonds show the estimates  based on surveys from June 2023. b) Blue lines show monthly data on the Purchasing Managers’ Index (PMI) for manufacturing. Red lines show monthly data on the PMI  for services. Last observation is September 2023. c) Lines show the median headline CPI inflation (yoy). Last observation is August 2023.  d) Bars show the share of countries where the policy rates have increased, decreased, or remained unchanged in the specific quarter.  Euro Area is disaggregated into constituent countries. Last observation is Q3 2023. Monetary tightening will continue to weigh on the global recovery but appears close to its peak. Headline and core inflation are decelerating, with global headline inflation almost cut in half since the beginning of the year, reaching 4.7 percent in September 2023 (Figure 9.3c). In most AEs, inflation remains above target, which led to further tightening monetary policy in Q2 2023. In contrast, significant progress has been made in many EMDEs, as many central banks have recently paused or lowered policy rates (Figure 9.3d). Though the lagged effect of the monetary tightening will continue to weigh on economic activity, it appears close to its peak. At the same time, the phasing-out of fiscal support due to energy price shocks will also prevent a more dynamic recovery. 42 9. Reforms are needed to consolidate the recovery and move toward sustainable growth TOWARD SUSTAINABLE GROWTH (Box 9.1 continued) Growth in the euro area is expected to be anemic in 2023 before gradually improving in the coming years. Economic activity has been sluggish in the euro area during H1 2023, with only 0.1 percent growth (qoq) each quarter. Most of the high-frequency indicators, including PMI and retail sales, point toward a deterioration of activity in the short term. This momentum will also weigh on growth in 2024. Moreover, declining but still high inflation will likely result in a ‘higher-for-longer’ interest rates environment, and continue to impact domestic demand adversely. Consumption will, however, remain the main growth driver as real wages catch up gradually. This overall lack of dynamism will negatively impact the WB6 region, as close to 45 percent of its total exports of goods go to the euro area. As growth will stay below its pre-pandemic trend, the convergence process toward the EU will take time. Risks to the global and regional outlooks remain tilted to the downside in the context of Russia’s invasion of Ukraine but have partially receded. In March 2023, the collapse of multiple banks triggered a surge in market volatility and a decline in bank equity prices, and thus fear of contagion of financial stress. The financial tensions have abated over the past six months. In addition, both headline and core inflation have decreased. However, they remain elevated in the ECA region, and the risk of more persistent inflation that would trigger further tightening of monetary and financial conditions cannot be excluded. In this scenario, the WB6 countries, which are characterized by high levels of foreign currency exposure or debt rollover needs, would face challenges. In addition, the high political uncertainty in ECA is mainly associated with the possibility of an escalation of the war in Ukraine and could lead to further geopolitical tensions. 9. Reforms are needed to consolidate the recovery and move toward sustainable growth 43 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 10. Spotlight: Greening Agriculture in the Western Balkans27 The WB6 agriculture sector is becoming agriculture varied from 18.4 percent in Albania smaller as a share of GDP, while remaining to 5–8 percent in other WB6 countries, while important in terms of value added and the contribution to employment ranged from employment, and contributing toward 34.6 percent in Albania to 7.4 percent in environmental sustainability and climate Montenegro. This compares with an EU27 resilience. As the sector is undergoing an GDP share of agriculture at only 1.6 percent, important structural transformation, efforts and an employment share of just 4.1 percent. to green agriculture are also important to ensure access to the EU market and The WB6 agriculture sector, with should be viewed as complementary to few exceptions, is still characterized that transformation. by low productivity and weak export competitiveness, complicated by deeply While the size of the agriculture sector is rooted structural problems. Compared with shrinking, it remains significant in most the EU27 average farm size (16 ha per farm), WB6 economies, both in terms of GDP and the average farm size in the WB6 is almost one- employment  (Figure 10.1a). The agriculture third (Serbia) to one-tenth (Albania) the size sector no longer accounts for 20 percent of of the EU27 average, discouraging investment. GDP in North Macedonia and 57 percent Farm labor and land productivity are also in Albania, as it did in the early 1990s, but very low due to underinvestment in capital it is nonetheless much larger than in the EU formation, and research and advisory services, (Figure 10.1b). In 2021, the GDP share of as well as the continued engagement of many Figure 10.1. Structural transformation of the WB6 agriculture sector a. Convergence of the WB6 agriculture sector with b. Agriculture as a share of GDP and employment in the EU, 1991–2021 the WB6 and the EU27 in 2021 Agriculture value added (percent of GDP) 40 EU27 MNE 30 1999 MKD 20 1999 2019 KOS 1999 SRB 1999 10 2019 2019 2019 BiH 2019 1999 2019 ALB 0 0 10 20 30 40 50 60 70 0 5 10 15 20 25 30 35 40 Employment in agriculture (percent) Q EU Q MKD Q MNE Q SRB Q BiH Q ALB J Share of agriculture in employment J Share of agriculture in GDP Source: World Bank Development Indicators, 2023. 27 This Spotlight was prepared by the team that included Sergiy Zorya (Lead Agricultural Economist, SCAAG), Fang Zhang (Agriculture Economist, SCAAG), Demetris Psaltopoulos (Professor of Department of Economics, Aristotle University of Thessaloniki), and Goran Zhivkov (Seedev Consulting). 44 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH households in subsistence farming.28 The skills century (Knez et al., 2022). More frequent of the primary agriculture sector’s labor force frost had a negative effect on wheat yields in are limited due to low educational levels and all WB6 countries, with the strongest impact a lack of opportunities for training, which also in Serbia (Muller and Hofmann, 2022). limits the sector’s contribution to generating Climate change associated with disasters and added value and off-farm jobs, diversifying the low preparedness for climate change, livelihoods in rural areas, and raising rural has already resulted in WB6 agricultural incomes.29 Younger and more educated people production becoming more volatile than in the are more likely to migrate away from rural EU (Figure 10.2). Thus, assisting producers areas. Other challenges, including underfunded and governments with adaptation plans and and weak institutional capacity, weak linkages practices to avoid the worst consequences of among agrifood value chain actors, (still) little climate change could have substantial impacts buy-in in climate smart technologies, and food on the WB6 agriculture sector. As such, supply vulnerabilities caused by climate change, accelerating support for the broad adoption of are all adversely affecting agrifood productivity climate-smart agriculture (CSA) is an urgent and its contribution to the economy. call. The World Bank defines climate-smart agriculture (CSA) as an integrated approach The WB6 is among the global hotspots of to tackle three main objectives: sustainably climate change, with above-average warming increasing agricultural productivity and and highly vulnerable populations employed incomes; adapting and building resilience to in agriculture. The accelerated climate change climate change; and reducing and/or removing is triggering more frequent and intense greenhouse gas emissions, where possible. hazardous weather events, which endangers the sector’s contribution to the broader economy. Figure 10.2. Changes in agricultural value added in the WB6 and the EU, 2010–2022 In May 2014, catastrophic floods hit the WB6 Index (2019=100) countries, causing damage to BiH estimated 120 to be equivalent to 15 percent of GDP, while 115 making 12,000 ha of land unusable in Serbia. 110 Most recently, in January 2023, floods caused 105 huge damage and drownings, and affected 100 thousands of hectares of land in northern 95 Albania.30 Droughts have also become more 90 frequent. These not only reduce crop yields 85 but also contribute to soil degradation and 10 11 12 13 14 15 16 17 18 19 20 21 20 20 20 20 20 20 20 20 20 20 20 20 ▬ WB6 ▬ EU long-term water scarcity. Increasingly frequent Source: World Bank Development Indicators, 2023. and intense droughts during the last two Note: Agricultural value added is in constant 2015 US$. decades have already caused great damage to agriculture in Serbia. Production is expected to fall by 10 percent in the second half of this 28 World Bank. 2018. Exploring the Potential of Agriculture in the Western Balkans. Washington, DC. 29 World Bank. 2017. Agriculture for Jobs and Growth in the Western Balkans: A Regional Report. Washington, DC. 30 https://balkaninsight.com/2023/01/20/floods-in-western-balkans-cause-huge-damage-drownings/ 10. Spotlight: Greening Agriculture in the Western Balkans 45 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Box 10.1. The New EU CAP The Common Agricultural Policy (CAP) is one of the oldest and most comprehensive policies of the EU, and accounts for nearly 40 percent of the EU’s total common budget. With many objectives in place, such as supporting farm incomes, becoming competitive on global markets, producing healthy foods at affordable prices, and improving living conditions in the rural areas, more recently managing natural resources in a sustainable manner and agriculture’s greening have become new priorities. The CAP greening started in 2014 with discussions on measures such as farmland set aside for biodiversity, minimum areas for organic farming, and the reduced use of plant protection products and fertilizers. Finally, in December 2021, the agreement on the New CAP reform was formally adopted for the period of 2023– 2027. The New CAP supports agriculture in making a much stronger contribution to the EU Green Deal (EGD) goals to become climate neutral in 2050.a Under the New CAP, there is a direct link to the EGD targets.b Payments to beneficiaries are linked to a stronger set of conditionalities instead of previous weaker cross-compliance measures. There is a higher share of eco-schemes targeting organic farming, animal welfare and others (at least 25 percent of direct payments). Rural development measures need to include climate, biodiversity, animal welfare and environmental targets (at least 35 percent of rural development funds). Forty percent of the budget will have to be climate-relevant and support biodiversity. EU member states should reduce the use of fertilizers by 20 percent and pesticides by 50 percent by 2030. At least 25 percent of the EU’s agricultural land should be under organic farming. The sale of antimicrobials for farmed animals and in aquaculture should be reduced by 50 percent by 2030. Nutrient losses should be reduced by at least 50 percent, while ensuring no deterioration in soil fertility, and bringing back at least 10 percent of agricultural area under high diversity spaces are called for by 2030. a. https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en b. https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2019%3A640%3AFIN The WB6 agriculture sector has a relatively per capita are close to the EU with Serbia low carbon footprint but the emission exceeding.31 Despite the low carbon footprint, structure and per capita are similar to the the WB6 authorities seem to be committed to EU. In 2020, it accounted for a relatively low promoting both adaptation to, and mitigation 0.2 percent of global agricultural methane and of, climate change. The Sophia Declaration, nitrous oxide emissions. The carbon footprint which was signed in 2020,32 launched the WB6 of the WB6 agriculture sector is almost 40 Greening Agenda, facilitating an inclusion of times smaller than the EU while emission greening agriculture in the WB6 new strategic 31 The figures are 0.4 percent for Serbia, 0.1 percent for North Macedonia, and 0.03 percent for Montenegro. 32 The leaders from the WB6 countries gathered in Sofia on November 10, 2020, at the WB Summit under the framework of the Berlin Process initiative and adopted the Document on the Green Agenda for the Western Balkans, laying down the key initiatives aimed at a green transition for the region. 46 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH Figure 10.3. Agricultural exports from the WB6 to the EU a. Export of agricultural products from the WB6 to b. Share of agricultural export to the EU in total the EU (2012–2022) export (av. 2018–2020) US$ billion Percent 6 70 66 5 60 4 50 48 45 40 3 30 2 30 20 1 10 0 10 6.7 0 10 11 12 13 14 15 16 17 18 19 20 21 22 20 20 20 20 20 20 20 20 20 20 20 20 ALB BiH MNE MKD SRB KOS 20 J EU13 (new member states) J EU15 (old member states) Source: World Bank staff calculations based on national trade statistics. plans for agriculture and rural development. Thus, going forward, strengthening the Most of these strategic plans include specific WB6 countries’ commitment and actions quantitative targets as commitments and on greening agriculture is critical for budgets, similar to the New EU Common transforming the sector, and generating Agricultural Policy (CAP) strategic plans (Box multiplier effects for jobs, growth, and 10.1). climate resilience. The WB6 countries have the potential to provide high-quality, ecologically Supporting climate mitigation measures is friendly, and competitive agrifood products critical for the WB6 not only to align with and should capitalize on this advantage. the EU Green Deal (EGD) as part of the Most of the WB6 countries have access to the EU accession, but also to maintain access to Instrument for Pre-Accession Assistance for the EU market. The EU increasingly requires Rural Development (IPARD) funds and other exporters to meet similar environmental funds for greening agriculture, and will receive requirements as introduced in the EU under the more funding for this purpose after joining EGD. In 2022, the WB6 agricultural exports the EU. The European Commission’s (EC) to the EU reached US$5.7 billion, increasing Economic and Investment Plan for the Western more than twofold since 2010 (Figure 10.3a). Balkans33 refers to the EGD as a blueprint for The EU market accounts for almost 50 percent joint action aimed at a green transition, while of North Macedonia and Serbia’s agricultural the accompanying Staff Working Document34 exports, while reaching 66 percent for Albania sets out a Green Agenda for the WB6 countries (Figure 10.3b). Going forward, maintaining and proposes relevant actions, including actions and increasing WB6 access to the EU market for agriculture. This Spotlight sheds light will require doing more on climate mitigation. on the current state of greening of the WB6 agriculture sector and the way forward using the lessons learned from the EU experience. 33 EC. 2020. North Macedonia 2020 Report. Commission Staff Working Document Accompanying the 2020 Communication on EU Enlargement Policy. SWD (2020) 351 final. Brussels. 34 EC. 2020. An Economic and Investment Plan for the Western Balkans. COM (2020) 641 final, Brussels. 10. Spotlight: Greening Agriculture in the Western Balkans 47 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 The low current environmental footprint share of high-diversity landscapes, especially in of the WB6 agriculture sector is more an BiH, exceeds that of the EU. Thus, the WB6 unintended outcome of still high rurality and low farming intensity than a result countries are in a good position to meet many of strategic policy choices. EGD targets by 2030, in the case that they are required to do so as part of EU accession (Table In some respects, the WB6 agriculture sector 10.1b). is relatively more environmentally friendly than that of the EU. On average, most WB6 Average use of fertilizers and pesticides in countries use less fertilizers and chemicals the WB6 countries, with the exception of (pesticides, insecticides, herbicides, etc.) per Montenegro, has been relatively low and hectare (Figures 10.4a and 10.4b), and emit trails behind the averages in the most EU less greenhouse gas (GHG) emissions per member states ( Figures 10.4a and 10.4b). The capita (Table 10.1a). In some countries, the WB6 region has a high proportion of small- Table 10.1a. Agriculture GHG emissions per capita in the WB6 vs the EU27 (CO2eq t/pc) ALB BiH MNE MKD SRB EU27 Agrifood systems 1.6 1.8 1.7 1.5 2.9 2.4 Emissions on agricultural land 1.1 0.9 0.7 0.6 1.9 1.3 AFOLU 0.9 0.3 0.7 0.6 0.9 0.5 Source: World Bank staff estimates using various sources and latest available data. Table 10.1b. WB6 vis-à-vis the EU27 in meeting the EGD targets for agriculture EU EGD Ambitions ALB BiH KOS MNE MKD SRB EU27 targets Organic farming 25% 0.1 0.1 0.4 1.8 0.4 0.7 8.0 (% of land under organic farming) by 2030 High-diversity landscape 10% n/a 30.0 n/a n/a 2.4 6.5 4.6 (% share of fallow land in UAA)a by 2030 Use of fertilizers -20% (% change between 2018–19 -10.4 -24.5 n/a +21.9 -8.1 -44.0 +3.8 by 2030 average and 2012–14 average) Use of pesticides -50% (% change between 2012–2014 -52.0 +8.0 n/a +12.0 0.0 n/a +6.6 by 2030 average and 2018–2020 average) Individuals using the internet 100% 82.6 78.8 n/a 88.2 83b 83.5 88.8 (% of population) (WDI 2022) by 2030 Protected areas as % of land 30% 14.0 4.0 11.0 9.0 15.0 8.0 24.0 (data 2022) by 2030 GHG emissions from agriculture -55% (% change between 2017 and 2019 25.2 79.5 n/a -12.5 -31.6 -12.5 -20.1 by 2030 average and 1990) A minimum % of public spending (Pillar 1 of EU, Measure 4 of IPARD 2 n/a n/a 5 1 14 25 25% III) on agri-environmental measures Cross-compliance No No No No No No Yes Yes Source: World Bank staff estimates using various sources and latest available data. Note: “-” means a decline and “+” means an increase. a) Fallow land refers to agricultural land that is intentionally left uncultivated or unplanted for a certain time, often as part of crop rotation or land management. b) Internet access data for North Macedonia is available as of 2021. 48 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH Figure 10.4. Use of fertilizers and chemicals in the WB6 and the EU, 2018–2020 a. Fertilizer consumption in kg per ha of arable land, b. Use of pesticides in kg per ha of arable land, 2020 av. 2018–2020 300 12 269 250 10 200 8 6.21 156 150 6 100 4 2.43 50 2 1.1 MKD 0.21 0 0 BEL NLD SVN HRV PRT CYP POL DEU FRA CZE ESP EUU HUN GRC DNK LTU BGR ITA SVK AUT LVA SWE MLT FIN EST ROU ALB BiH MKD MNE SRB KOS NLD CYP IRL BEL ITA PRT SVN DEU AUT FRA GRC ESP FIN POL HUN LUX HRV LVA CZE SVK DNK BGR LTU EST SWE ROU ALB BiH MNE Source: World Bank staff estimates using FAO and national sources. Note: Serbia does not officially publish the data on pesticides. scale or subsistence farms, where the use of Figure 10.5. Crop yields in the WB6 vis-à- modern inputs is rather limited. The use of vis the EU27 (av. 2018–2020) Percent in comparison with EU average modern inputs among commercial farmers is 40 also limited due to inadequate access to finance 20 and low levels of productivity. Furthermore, the 0 WB6 region is still predominantly rural with -20 32 percent of the population in Montenegro to -40 50 percent in BiH living in rural areas (WDI -60 2022). The rurality defines people’s approach -80 to food, agriculture, and the environment. -100 es ns y ze n o er at rle at io he ow ai pl People living in rural areas may have a closer ea On t Ba M Po Ap W yb nfl So connection to nature and rely more directly on J ALB J BiH J MNE J MKD Su J SRB natural resources for their livelihoods. Source: World Bank staff estimates using FAOSTAT data. The average crop yields in the WB6 countries countries. Other countries rely on cereal and are far lower than in the EU, with the exception meat imports. Albania and BiH generally have of Serbia. In part, low input use contributes to lower yields, except for stone fruits in BiH the WB6 region’s low yields, but by no means and indoor perishable vegetable production is this the only, or most critical, reason for this. in Albania. Montenegro has relatively small Serbia stands out with higher average yields primary production and this is mainly compared with other WB6 countries (Figure focused on fodder and self-sufficient vegetable 10.5). Serbia accounts for about two-thirds of farming that adopts highly intensive methods the WB6 region’s production, and exports of where manual labor handles weed removal, cereals and industrial crops (maize, sour cherry, harvesting, and planting. Such intensive, yet plum, peach, strawberry, carrot, and processed environmentally friendly, agricultural practices food and beverages).35 However, yields in are observable in other WB6 countries as well. Serbia are still below the best-performing EU 35 World Bank. 2018. Exploring the Potential of Agriculture in the Western Balkans. Washington, DC. 10. Spotlight: Greening Agriculture in the Western Balkans 49 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 10.6. Livestock herd density in the WB6 and the EU, 2013–2020 a. Livestock unit per ha, 2020 b. Trends in livestock units by country, 2013–2020 4.5 0.9 4.0 0.8 3.5 0.7 3.0 0.6 2.5 0.5 2.0 0.4 1.5 0.3 0.8 1.0 0.2 0.5 0.5 0.3 0.3 0.5 0.2 0.1 0 0 NLD BEL MLT DNK IRL LUX DEU CYP AUT FRA EU27 ITA SVN PRT ESP SWE POL FIN HRV CZE HUN GRC SVK EST ROU LTU LVA BGR ALB BiH MNE MKD SRB 2013 2014 2015 2016 2017 2018 2019 2020 ▬ ALB ▬ BiH ▬ MNE ▬ MKD ▬ SRB ▬ EU27 … Sample average WB6 Source: World Bank staff estimates using FAOSTAT data. The extent and intensity of livestock Figure 10.7. GHG emissions by sector and country in the WB6, 2020 production in the WB6 countries have been Percent low and declining, resulting in a relatively 100 low carbon footprint from livestock. The 90 density of animals in the WB6 region, at 0.4 80 70 per ha, is lower than the average livestock 60 density in the EU. Indeed, it is much lower 50 than in the EU countries with large livestock 40 30 herds, such as the Netherlands, Denmark, 20 and Austria, where land is limited, requiring 27.7 10 9.6 13.1 8.2 3.2 6.0 7.1 highly intensive production methods and 0 ALB BiH MNE MKD SRB KOS EU27 practices to overcome land constraints (Figure J AFOLU J Energy J IPPU J Waste J Other Source: FAOSTAT, 2023. 10.6a) The WB6 region is characterized by a long-term stagnation in livestock production and productivity, indicating the difficulty for from agricultural growth. In most WB6 WB6 farmers to manage more capital and countries in 2020, the agriculture sector labor-intensive technologies, exacerbated by generated about 10 percent of total emissions strict requirements on food safety, traceability, (Table 10.2). The share was large only in and animal welfare in the EU that affects the Albania, at 28 percent. In comparison, the WB6’s export of livestock products there. They agriculture sector globally generates more than choose instead to engage in crop production. 25 percent of total emissions. During 2010– As a result, the WB6 countries are experiencing 2020, annual average agricultural growth of the a decreasing trend in livestock production, WB6 region was 0.9 percent, while agricultural except for poultry (Figure 10.6b). methane and nitrous oxide emissions annually declined by 1.3 and 1.4 percent, respectively The low intensity of crop and livestock (Figure 10.7). In comparison, the EU production has contributed to the relatively agriculture sector grew by 0.4 percent annually low level of GHG emissions in the WB6 during 2010–2020, while agricultural methane agriculture sector, as well as their decoupling emissions declined annually by 0.4 percent. 50 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH Table 10.2. Agricultural growth and GHG emissions in the WB6 and the EU, 2010–2020 Annual average growth Annual average growth Annual average Regions of agricultural methane of agricultural nitrous agricultural growth, % emissions, % oxide emissions, % EU 0.4 -0.4 0.0 WB6 0.9 -1.3 -1.4 Source: World Bank staff estimates using the World Development Indicators. Agricultural nitrous oxide emissions have not Figure 10.8. Agricultural budget support declined at all in the EU over the past decade. in the WB6 and the EU27 in percent of GDP This implies that agricultural growth in the WB6 region was much more decoupled from ALB 0.19 GHG emissions than in the EU. BiH 0.27 MNE 0.29 EU27 0.35 WB6 agricultural public expenditures, while substantial in terms of amounts/ SRB 0.36 levels to influence on agricultural MKD 0.56 production, have not yet prioritized financing of greening and climate-smart KOS 0.68 agriculture. 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 Percent WB6 agricultural public expenditures have Source: World Bank staff calculations using the data from Standing Working Group (SWG) for the WB6 countries and EUROSTAT. been substantial and are growing, providing Note: Public expenditures and GDP are the average of 2020 and 2021. a good foundation for making funds available for the green transition. During National, IPARD, and development partner 2020–2022, North Macedonia36, Kosovo, and funding has been readily available to finance Serbia allocated more funds for agriculture as a CSA measures in the WB6 region. As a result, share of GDP than the EU27 (Figure 10.8).37 the agri-environmental/CSA budget increased However, as a share of agricultural value annually by 24 percent on average for all WB6 added, WB6 support was only half of that in countries from 2012 to 2021 (Figures 10.9a the EU27, implying that WB6 farmers are less and 10.9b). Growth is particularly noticeable dependent on state support, thereby offering after 2020, driven by increases in Serbia and the authorities an opportunity to reform North Macedonia. Moreover, the third phase agricultural public expenditure for enhanced of the IPARD funds, available for all WB6 support of greening the sector without large countries except BiH and Kosovo, is projected losses to farmers. Only Albania stands out as a to reach EUR 115 million in 2027, which is country in the WB6 region with a comparably three times more than the EUR 38 million low level of agricultural support, requiring budget provided in 2021 (Figure 10.10). All both spending more and spending better going WB6 countries offer a menu of options to forward. select from and invest in agri-environmental measures under the sub-measure "Agri- 36 World Bank. 2023. Green Growth in North Macedonian Agriculture. Washington, DC. 37 Overall agricultural budget support in the WB6 region is probably even higher. WB6 farmers receive tax exemptions and fuel subsidies such as for blue fuel. However, the data on these expenditures are not readily available and, thus, not added here. 10. Spotlight: Greening Agriculture in the Western Balkans 51 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 10.9. Public expenditures for agri-environmental measures in the WB6 region, 2012–2021 a. Support for agri-environmental measures in the b. Agri-environmental measures in percent to total WB6 countries agricultural budget Percent EUR million 3.5 8 3.0 2.9 7 6 2.5 2.2 2.2 5 2.0 4 1.5 1.2 3 1.1 1.0 1.1 2 0.5 0.4 0.6 1 0.3 0 0 12 13 14 15 16 17 18 19 20 21 20 20 20 20 20 20 20 20 20 2013 2014 2015 2016 2017 2018 2019 2020 2021 20 ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB J ALB J BiH J KOS J MKD J MNE J SRB Source: World Bank calculations using the SWG data and national budgets. environment-climate and organic farming". Figure 10.10. IPARD III allocations by the The most popular measure has been organic eligible WB6 countries EUR million farming. Other proposed investments include 120 conservation of local breeds of small ruminants 100 and the preservation of genetic resources 58 (Albania and Montenegro), advanced crop 80 54 57 rotations (North Macedonia and Serbia), 60 43 green cover of permanent crops (North 31 18 20 40 25 17 Macedonia), establishment of pollinator strips 20 12 15 10 12 13 20 9 (Serbia), sustainable management of pastures 7 8 6 8 5 19 23 24 10 12 16 8 (Montenegro and Serbia), and livestock waste 0 2021 2022 2023 2024 2025 2026 2027 management (Montenegro). J ALB J MNE J MKD J SRB Source: World Bank staff estimates using the EU DG AGRI data. Despite increasing, actual spending on CSA/ agri-environmental measures has remained options in the IPARD or national budgets for modest. In the country with the largest recent investments in measures that do not require increase in spending, i.e., North Macedonia, such strict environmental standards. In this the share in total IPARD expenditures grew regard, the adoption of CSA practices in the from 0.4 percent in 2013 to 1.2 percent in WB6 countries remains very small. In addition, 2021 (Figure 10.9b). The largest share of this commercial banks in the region do not offer any spending is seen in Montenegro, at a meager financial products to promote CSA practices 2.2 percent. In addition, when funds are or reward farmers for adopting CSA. Private offered for agri-environmental measures, these financing has also been limited in this area.38 are less popular among farmers than other 38 IFC. 2022. Potential Climate Smart Investments in Agriculture and Agribusinesses in Albania, North Macedonia, and Serbia. Western Balkans Agricultural Risk Management Facility. 52 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH The budget spent on the Agricultural innovative approaches. It is also important Knowledge and Innovation System (AKIS) to equip AKIS institutions with staffing, which combines agricultural education, knowledge, and infrastructure to design and research and farm advisory services has support implementation of even simple agri- been consistently low. This is one major environmental measures, while measuring unfavorable factor that constraints the sector and verifying environmental outcomes of from leveraging private finance, and a missed the support. Over time, they should be able opportunity to boost agricultural growth, since to administer the implementation of more innovation and digitalization play a crucial complex agri-environmental measures, such role in addressing environmental concerns and as eco-schemes, which are now required in the climate change in agriculture. A recent estimate EU. by the World Bank indicates that closing the 25 percent gap for investments in research Instead of supporting the CSA measures, and development, as a part of AKIS, with the most agricultural public expenditures in EU could increase agricultural productivity the WB6 region are used for direct farm by 15 percent in Albania, 25 percent in BiH, payments (Figure 10.11a), a large share of 16 percent in North Macedonia, and 6 percent which is coupled to production of specific in Serbia.39 Along with the weak capacity of crop and livestock products. In countries such AKIS institutions and ineffective service delivery as BiH, Kosovo, North Macedonia, and Serbia, models, the small budgets have undermined the the share of direct farm payments in total support for CSA adoption, proven to be critical agricultural budgets reaches 70–80 percent in the EU member states, for example. AKIS in (Figure 10.11b), most of which is coupled to the WB6 countries struggles to effectively raise livestock production or the use of fertilizers and productivity and competitiveness that it was chemicals.40 These measures are not subject to designed for, making it challenging to expect its minimum cross-compliance requirements (i.e., effective leadership on greening the agriculture good agricultural and environmental practices), sector. In addition, the current AKIS structure while they generate significant GHG emissions lacks a necessary expertise and knowledge in and bring other environmental damage, in digital agriculture and new technologies on addition to reducing overall agricultural climate adaptation and mitigation, which productivity and creating other market are crucial for tackling new challenges in the distortions.41 Less distortive decoupled support, region's changing landscape. Strengthening the which dominates the EU CAP, is still limited institutional capacity within AKIS by fostering in the WB6 countries. North Macedonia has collaboration between research institutions, recently committed to shift from coupled agricultural organizations, the private sector, to decoupled support and introduce cross- and policy makers would help bridge the compliance, in line with the EU requirements, existing knowledge gaps and facilitate the but the actual implementation of these actions dissemination of up-to-date information and remains to be seen. Other countries have yet to 39 World Bank. 2018. Exploring the Potential of Agriculture in the Western Balkans. Washington, DC. 40 EU. 2021. Recent Agricultural Policy Developments in the Context of the EU Approximation Process in the Pre-Accession Countries. Joint Research Center Technical Report. 41 World Bank. 2018. Exploring the Potential of Agriculture in the Western Balkans. Washington, DC. 10. Spotlight: Greening Agriculture in the Western Balkans 53 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 10.11. Functional composition of agricultural public expenditures in the WB6 and the EU a. Total agricultural expenditures in the WB6 b. Composition of direct farm payments, 2019–2021 EUR million Percent 900 100 800 90 700 80 600 70 60 500 50 400 40 300 30 200 20 100 10 0 0 12 13 14 15 16 17 18 19 20 21 20 20 20 20 20 20 20 20 20 ALB BiH KOS MKD MNE SRB EU27 20 J Market and direct payment J Structural and RD J Other measures J Direct payments based on outputs J Direct payments based on current area/animal J Variable input subsidies J Decoupled per hectare support J Disaster and other compensation to producers J Other support Source: World Bank staff calculations using the data from SWG for WB6 countries. introduce cross-compliance as a condition for Furthermore, funds spent on coupled support farmers to receive support. crowd out capital investments, undermining long-term competitiveness and climate Coupled direct payments are most resiliency. This can be already seen in the WB6 distortive as they usually reduce agricultural countries where the level of investments in productivity and contribute to GHG farm capital formation remains small, and the emissions. In 2018, the World Bank concluded gap with the level in the EU is huge (Figures that improvements in agricultural productivity 10.12a and 10.12b).44 Little public spending and employment in the EU went hand in hand on stimulating private capital investments is a when supported by decoupled CAP payments missed opportunity in the WB6 region, where of both Pillar 1 and Pillar 2, but not the coupled agriculture is dominated by small farms that payments under Pillar 1.42 This is because require public co-financing of investments to farmers, when they no longer receive subsidies be able to afford them in principle. Efforts to coupled to the production of low value-added re-orient public support to agriculture from crops, switch to higher value-added crops. The coupled payments to decoupled support could same conclusion was derived from the analysis contribute to increasing productivity across the of agricultural support in the WB6 countries WB6 region. during 2011–2015, namely that support coupled to the production of specific crops was found to reduce agricultural productivity, while decoupled support had a positive and significant effect on agricultural productivity.43 42 World Bank. 2018. Thinking CAP: Supporting Agricultural Jobs and Incomes in the EU. EU Regular Economic Report No. 4, Washington, DC. 43 World Bank. 2018. Exploring the Potential of Agriculture in the Western Balkans. Washington, DC. 44 The recent estimate of the World Bank indicates that closing one-quarter of the gap in the stock of agricultural capital per worker relative to EU27 levels would increase agricultural labor productivity by 76 percent in Albania, 82 percent in BiH, 30 percent in Serbia, and 6 percent in Montenegro. 54 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH Figure 10.12. Investments in capital formation in agriculture in the WB6 and the EU a. Gross capital formation per worker in agriculture b. Investment ratio agricultural orientation index, in 2020 2020 Value in constant 2015 US$, in thousands 12 1.6 1.52 10,159 1.4 10 1.2 8 1.0 6 0.8 0.73 0.64 0.59 0.6 4 0.4 0.35 2 0.19 829 1,004 0.2 284 570 603 0 0 MKD MNE ALB BiH SRB EU27 MKD MNE ALB BiH SRB EU27 Source: World Bank staff calculations using the data from WDI and FAOSTAT. Note: Investment ratio orientation index is calculated as a share of gross fixed (private) capital formation in agriculture per unit of value added in agriculture over the share of gross fixed capital formation in other sectors per unit of value added in those sectors. While more attention is increasingly to the adequacy of funding mechanisms, the being given to greening the WB6 availability of technological solutions necessary agriculture sector to deepen and accelerate the green transition, to achieve the EGD targets, the suitability of historical roadblocks need to be CSA technologies to specific agroecology in the removed. WB6 region, institutional requirements, and Many structural barriers, including those socio-economic implications of the change, discussed above, also slow down climate including potential job losses in agriculture. adaptation. A relatively high rurality in the The extent to which the EU can effectively WB6 countries underpins the slow change of find internal strengths to carry out all these attitude toward agriculture commercialization processes is also uncertain. Moreover, the EGD and greening. The small farm size prevents a requires a comprehensive framework of laws wider adoption of CSA technologies that have and regulations to guide its implementation. proven successful elsewhere but that require The exact details of these legislative measures, scale for cost-effective adoption. Moreover, including timelines, targets, and enforcement underinvestment in AKIS and other public mechanisms, are still being developed. As institutions and lagging digitalization, which are policy makers in the WB6 countries support critical to design and support implementation the EGD actions, focusing primarily on of more complex agri-environmental measures, aligning their efforts with direct EU initiatives hamper CSA adaptation. and not having own, the ongoing discussions and implementation will shape the position Given the low carbon footprint nature of the and actions of the WB6 countries. WB6 agriculture sector, climate mitigation historically was not given a high priority First, climate change makes climate by WB6 authorities. WB6 authorities are adaptation of the agriculture sector more also awaiting further results from EGD urgent, requiring public support (AKIS, implementation. Uncertainties remain around public institutions, budget) to help farmers EGD implementation, for example related enhance their climate resiliency investments. 10. Spotlight: Greening Agriculture in the Western Balkans 55 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 There is also a need to increase or shift public enhanced feeding practices, cultivation of spending for AKIS toward climate-resilient cover crops or integration of green manure, agricultural practices and technologies. An efficient water management, and integrated IFC study has estimated the financial costs and pest management. investments of several types of CSA technologies that could be implemented by WB6 farmers on Second, the need to maintain access to a commercial basis (Table 10.3). The potential the EU market and the EU accession of increasing commercial adoption of CSA commitments should encourage more technologies for irrigation, land cultivation, investment in climate mitigation and greenhouses, and livestock is estimated to CSAs/sustainable practices. Competitive cover 92,000 ha in Serbia, 25,000 ha in North export-oriented producers in WB6 countries Macedonia, and 19,000 ha in Albania.45 It are proactively adjusting their practices and would be highly valuable to conduct a similar operations to comply with new EU rules and exercise for assessing a potential application of standards. The defined minimum residue level various CSA practices, such as conservation influences pesticide use, which significantly agriculture, improved nutrient management, affects the adoption of sustainable practices by Table 10.3. Potential for adoption of CSA technologies in selected WB6 countries Potential for commercial adoption Technology Estimated Cost Units Serbia North Macedonia Albania Pivot Irrigation US$1,050/ha ha 16,000 23,616 17,530 Drip Irrigation US$2,100/ha ha 1,270 1,181 1,210 Greenhouse US$4,594/0.25 ha ha 324 20 Irrigation Pump Replacement US$555/ha ha 2,175 Pump Upgrade US$210/ha ha 2,175 US$20,000/ Tillage Equipment ha 70,056 machine Cattle Genetics US$1,785/animal cattle heads 2,372 3,214 2,780 US$1,100/ livestock Electric Fencing 1,582 1,422 506 enclosure heads Hydroponic Upgrade US$15,251/0.1 ha ha 1.3 14 Boiler Heater US$9,844/0.25 ha ha 0.25 Greenhouse US$50,000/0.1 ha ha 142 20 Expansion On-farm Solar US$22,042/yard # of farmers 28,223 8,906 9,643 Total potential for ha 92,143 24,837 18,754 adoption % of total 4% 6% 3% arable land livestock 3,954 4,636 3,286 heads Source: IFC, 2022. 45 IFC. 2022. Potential Climate Smart Investments in Agriculture and Agribusinesses in Albania, North Macedonia, and Serbia. Western Balkans Agricultural Risk Management Facility. 56 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH farmers in the WB6. The widespread adoption the reduction of GHG emissions. Pillar of Global Gap standards by the WB6 export- 2 measures47 offered a wide range of tools oriented producers, as required by the EU and potentially beneficial to the environment most other sophisticated markets, has become and climate. This includes agri-environment- unquestioned to ensure product quality, safety, climate measures, which provide public goods and meet international market requirements. in climate change mitigation and adaptation, Thus, increasing requirements for accessing the and protection and improvement of ecosystem EU market will be a great driver for changes services. in the environmental standards of the WB6 countries. Cross-compliance is an important cross- cutting tool to generate environmental Lastly, rapidly developing digitalization benefits that also increase productivity. Cross- can help overcome some structural and compliance provides foundations of minimum institutional constraints for the adoption requirements for farmers on environment and of CSA measures, as demonstrated in climate, and links CAP measures to farmers’ the EU. The private sector may increase its compliance with basic standards and the interest in providing agricultural green/carbon application of good agricultural practices. It financing if digitalization helps reduce the should be meaningfully strict and enforced if it cost of monitoring, results measurement, and is to make an impact. verification, as well as the adoption of CSA technologies themselves. Another cross-cutting measure relevant to environment and climate is Farm Advisory Systems (FAS). FAS are compulsory for the The EU can offer important lessons EU member states and facilitate farmers’ for the green transition of the WB6 awareness of farm practices and various agriculture sector, particularly its experience on policies and public standards. FAS provide advice for topics spending on climate mitigation and CSA including cross-compliance rules, green direct adoption. payments requirements,48 basic requirements As part of the reforms of the New EU CAP, on maintaining agricultural land to be eligible the transition to decoupled farm support for direct payments, climate change mitigation has helped reduce the carbon footprint of and adaptation, etc. Serbia and North the agriculture sector. In addition, green Macedonia have made significant progress in direct payments46 of the 2014–2020 CAP strengthening their agriculture advisory areas, Pillar 1, supporting farmers for activities going but still have an underdeveloped agricultural beyond minimum requirements, have aimed R&D infrastructure and agricultural at enhancing the environmental performance education. Overall, there is no clear role and of farm activities and contributed most to strategy for extension services, nor engagement 46 Aiming to maintain crop diversity and permanent grassland and promote biodiversity-friendly practices. 47 Pillar 2 measures included agri-environment-climate measures, which reward farmers for adoption of practices (defined in the national rural development programs) that go beyond cross-compliance and greening requirements under Pillar 1. 48 The greening payment covered the whole eligible area of farm holding (including permanent crops), while obligations applied only on arable land and permanent grassland areas. They introduced three practices, namely crop diversification, maintenance of permanent grasslands, and Ecological Focus Areas (EC, 2017). 10. Spotlight: Greening Agriculture in the Western Balkans 57 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 and investment by private extension service capital development on aspects related to the providers in the WB6 countries. environment and climate. Knowledge transfer and information actions have funded vocational However, the power of the CAP on climate training, workshops, etc. The cooperation change mitigation and adaptation seems to measure has supported innovation through not necessarily materialize in all countries. involving farmers in generation of innovative Those EU member states that did not strictly solutions to practical problems. enforce cross-compliance have not reduced GHG emissions. The provision of farm advice The above-mentioned lessons, learned from on climate performance improvements through past CAP implementation, shaped the New adaptation actions has been a low policy CAP. The EU, through the EGD and 2023– priority in many countries. Most mitigation 2027 CAP, incorporated an increased focus measures supported by the CAP have had a low on tackling climate change and promoting potential to mitigate climate change. Livestock a greener production model supported by emissions, mainly driven by cattle, represent allocation of public funds. The EU member around half of emissions from agriculture, states had to design CAP 2023–2027 while adoption of carbon-reducing livestock instruments in a manner that fulfils both the practices has been slow. objectives of the New CAP and the ambitions of the EGD through development of holistic Not all agri-environmental measures and integrated strategies. From January 2023, provided over a long time period generate the support for farmers and rural stakeholders significant positive environmental outcomes. across 27 EU member states has been based Some ended up as direct farm/area payment on the New CAP legal framework and the without environmental improvements. It takes choices detailed in the CAP Strategic Plans. time to learn from local adoption experience The plans are expected to make a significant to ensure a scaled-up adoption of impactful contribution to the ambitions of the EU F2F agri-environmental measures in the future. For and Biodiversity Strategies, as well as other instance, organic farming faces negative market elements of the EGD. headwinds in the EU and needs to be highly subsidy-dependent to survive. High emphasis EU member states are obliged to spend a on organic farming in the New CAP is more minimum of 40 percent of their CAP budget due to reducing the use of pesticides than on climate and the environment, and a increasing the supply of organic food. minimum of 35 percent of EAFRD budget (Pillar 2) on environment/climate in rural There were other area-based measures in development interventions. At least 25 percent Pillar 2 aligned with the CAP environment/ of the budget of direct payments (Pillar 1) is climate ambitions. These measures are allocated to eco-schemes, providing stronger complemented by support for investments incentives for climate- and environment- in physical assets to address environmental friendly farming practices and approaches. This improvements and facilitate resource efficiency new scheme involves annual commitments on- and off-farm (e.g., more efficient irrigation). and payments, and the possibility to combine Also, these measures have supported human 58 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH with other CAP interventions to jointly address all, could support a faster green transition in specific environmental and climate issues. the WB6 region. Most WB6 countries also spend sufficient amounts of national funds AKIS has a reinforced role vis-à-vis for agriculture; thus, funds are available in environment/climate issues. Together with principle to support the green transition, but FAS, AKIS will support farmers in making these funds need to be repurposed to make a sustainable management decisions. Also, difference for the Greening Agenda and, at the agricultural European Innovation Partnership same time, make structural changes that would (EIP-AGRI) will be funding innovative projects improve competitiveness. targeting the improvement of environment/ climate performance of farms. Eight policy recommendations are proposed to accelerate greening of the WB6 agriculture Lastly, but perhaps most importantly, the sector. These recommendations apply to all new green architecture of the CAP requires WB6 countries, given their relatively low strengthened capacity of public institutions baseline on CSA adoption and lack of concrete for supporting more complex but more CSA-enhancing programs on the ground: impactful agri-environmental measures. The new delivery model of the CAP gives a strong 1. Move from strategies to actions: M  ove emphasis on results and performance. Each EU from strategies to concrete policy actions member state has drawn up its CAP strategic aimed at promoting and adopting practices priorities, setting out how it will direct CAP that reduce GHGs, conserve natural funding toward specific targets, and how these resources, enhance climate resilience, and targets will contribute toward the overall and promote sustainable livelihoods for farmers. specific objectives of the CAP. These actions will require leveraging public policies and expenditures to scale up the support for CSA adoption, encouraging WB6 countries have an opportunity to research and innovation in CSA accelerate greening their agriculture, technologies, disseminating knowledge, making further structural transformation more just and resilient to climate coordinating actors involved in the agrifood change. systems, educating farmers and consumers about environment and climate impacts, Further structural transformation in the and monitoring and measuring impact. WB6 agriculture sector would require more proactive and concerted policy actions on 2. Improve the regulatory and institutional climate adaptation and mitigation, i.e., the set-up: U  se the EGD framework and green transition. Good initial conditions, such the New CAP developments to guide as the low intensity of the current farming investments and actions on institutional practices, greening of the recent national strengthening, while also being selective strategic plans, the IPARD funds’ availability on short-term priorities. Prioritize the for financing agri-environmental measures, support to climate adaptation and resiliency and the EU laboratory of innovations on now, while building capacity of public CSA development and adoption to learn from institutions, including piloting more 10. Spotlight: Greening Agriculture in the Western Balkans 59 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 complex agri-environmental programs including support for digital CSA and cross-compliance mechanisms, to platforms, AKIS and agri-environmental contribute more to climate mitigation demonstrations/pilots. Directly paying in the future. The latter requires strong farmers to supply public goods, institutions and mechanisms to be in place such as ecosystem services or carbon for successful scaled-up implementation. sequestration in agricultural soils, and Establishing and implementing a fully- to adopt resource-saving production functioning Paying Agency with integrated practices, would also help reduce systems, such as a Land Parcel Identification emissions and provide farmers with System and an Integrated Accounting and new sources of income. Montenegro is Control System, is crucial in this regard. projected to reduce the use of pesticides from 6 to 3 kg/ha and mineral fertilizers 3. Repurpose the budgetary support from 151 to 75 kg/ha and increase to increase the climate resiliency of protected areas from the current 10,000 agricultural production and productivity: to 20,000 hectares in 2028. a. Phase out market price and coupled 4. Step-up efforts for sustainable farm supportthat is known for its development of rural areas by potential to increase pressures on implementing Measure 5 (LEADER natural resources, reduce overall sector approach). The LEADER approach productivity, and inefficiency for involves simultaneous use of the territorial transferring income to farmers. approach, public-private partnerships, and integrated multi-sector approach. It b. Gradually transition to more was designed and developed by the EU as decoupled payments a nd encourage an instrument to build the social capital investments to co-finance capital and development of community in the expenditures for farm modernization development of the local development and CSA adoption as decoupled payment strategies contributing to the economic, may provide valuable ecosystem services social, cultural, and environmental that serve as better collateral assets. improvements of local areas.  or all direct farm payments, launch c. F  oster a. F cross-sectoral nature-based cross-compliance requirements, solutions by coordinating between starting with enforcing their minimum conservation and productive activities: level and gradually converging with supporting/providing incentives for higher standards adopted by the EU the implementation of sustainable farmers. land uses and management plans and approaches with attention to enhance d. Increase spending on Pillar 2 and diverse economic opportunities programs a nd Measure 4 & 5 of from the sustainable use of natural IPARD III dedicated to increase farm capitals (forests, land, blue economy) competitiveness and climate resiliency, and stimulate cross-sectoral solutions 60 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH to ensure a competitive green agrifood on organic farming as the main agri- value chain that mitigates increasing environmental measure is risky due to the climate risks. low viability of producing organic without continued state support and the weak b. Manage overgrazing, mountainous domestic demand. Support investments in pastures, and meadows of the WB6 the development of physical infrastructure countries, and monitor the livestock to enable the creation of alternative and sector development in the EU, w  hich sustainable economic opportunities as rural is under pressure to become more areas adapt to changing climate and counter climate friendly, for market directions deterioration of the rural landscapes and to inform and guide livestock subsector biodiversity loss. development. 7. Significantly strengthen knowledge 5. Adopt strategic targeting: transfer and agricultural knowledge and innovation system (AKIS) with financial a. Target matching grants u  nder IPARD resources, human capacity, and new and national programs to farmers who business models to facilitate efficiency are willing to borrow commercially for gains associated with CSA practices: CSA investments and improve on-farm efficiency and sustainability to meet a. Invest in agri-environmental data the demand for safe, nutritious, and collection and decision support tools sustainable food and animal welfare. (agroclimatic info, soil mapping and information, spatial zoning) with area/ b. Target measures and limit types of site-specific CSA options and empower recipients based on necessity to upgrade smallholder farmers to access digital to EU standards, production level, FAS. sustainability of production and size of recipients, in one measure subsistent b. Knowledge transfer and information and semi subsistent farms restructure actions through center-state schemes the size of the farms; in one measure and FAS to support human capital agricultural holdings designated to development on aspects related to the primary production upgrade to higher environment, climate, and finance and intensity production systems, while fund vocational training/workshops on in the other measure recipients are entrepreneurial and business skills. commercial enterprises dealing with marketing and processing.  ystematically develop digital channels c. S for CSA promotion and establish CSA 6. Support pilots for selected agri- dissemination channels (farmers field environmental measures informed by schools, farmers to farmers, digital local adoption experiences. Go beyond platform, etc.) to educate and train organic farming, supporting a wider range farmers on digital literacy, and guide of CSA technologies and practices. Reliance and support them in assessing the 10. Spotlight: Greening Agriculture in the Western Balkans 61 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Figure 10.13. Diversity of agri-ecology and greening opportunities in the WB6 countries Source: World Bank staff. digital channels for CSA knowledge, information on funding schemes and application processes. 8. Learn globally, implement locally. As the WB6 countries have a diverse set of agri- ecological zones and natural landscapes, which requires tailored solutions that would not work everywhere (Figure 10.13), it is important for each and every WB6 country to make the above-mentioned investments that enable CSA adoption, strengthen AKIS to help farmers choose suitable CSA technologies and practices, and enhance other public institutions critical for monitoring and verifying agri- environmental outcomes. Learn globally but implement locally is a precondition for successes at the country level in the WB6. 62 10. Spotlight: Greening Agriculture in the Western Balkans TOWARD SUSTAINABLE GROWTH References World Bank. 2023. Green Growth in North Macedonian Agriculture. Washington, DC. EC. 2020. North Macedonia 2020 Report. Commission Staff Working World Bank. 2018. Exploring the Potential of Document Accompanying the 2020 Agriculture in the Western Balkans. Communication on EU Enlargement Washington, DC. Policy. SWD (2020) 351 final. Brussels. World Bank. 2018. Thinking CAP: Supporting Agricultural Jobs and Incomes in the EC. 2020. An Economic and Investment Plan EU. EU Regular Economic Report for the Western Balkans. COM No. 4, Washington, DC. (2020) 641 final, Brussels. World Bank. 2017. Agriculture for Jobs and EU. 2021. Recent Agricultural Policy Growth in the Western Balkans: A Developments in the Context of Regional Report. Washington, DC. the EU Approximation Process in the Pre-Accession Countries. Joint Research Center Technical Report. IFC. 2022. Potential Climate Smart Investments in Agriculture and Agribusinesses in Albania, North Macedonia, and Serbia. Western Balkans Agricultural Risk Management Facility. Knez S. et al., 2022. Climate change in the Western Balkans and EU Green Deal: status, mitigation and challenges. Energy, Sustainability and Society, 12:1 https://doi.org/10.1186/ s13705-021-00328-y Muller D. and M. Hofmann. 2022. Impacts of climate change on agriculture and recommendations for adaptation measures in the Western Balkans. https://lsg.iamo.de/microsites/lsg. iamo.de/fileadmin/Dokumente/ Western-Balkan-08.07.2022.pdf References 63 Country Notes TOWARD SUSTAINABLE GROWTH Albania • After a strong rebound in 2022, GDP growth is forecast to moderate but remain above the historical average. • The labor market has improved, with employment and labor force participation increasing, and real wage growth slowing. • Inflation continued its downward trend, but pressures from domestic demand remain elevated. • External balances are expected to improve on account of expanding foreign tourism. • Albania is expected to show a positive primary balance in 2023. Recent Economic Developments economic indicators suggest GDP growth accelerated during Q2 and Q3 2023, with Following a strong performance in 2022, construction accelerating and tourist arrivals economic growth started to moderate early hitting a record high in July. Increased income in 2023 due to a slowdown in global demand, from employment, credit growth, business and which adversely affected Albania’s industrial consumer sentiment indicators, and strong tax output. In Q1 2023, GDP grew by 2.7 percent. revenues, suggest an increasing contribution to Services, including trade and real estate activity, growth from consumption, investment and net contributed 2.5 percentage points to quarterly exports in Q2 and Q3. GDP growth, followed by construction and manufacturing, while extractive industries and Employment grew by 2.7 percent yoy agriculture contracted. during Q2 2023. Increasing nominal wages and employment incentivized labor force On the demand side, private consumption participation (ages 15+), which continued to remained the main driver, following growth increase in line with previous years’ trends, of 6.9 percent in 2022 vis-à-vis a negative reaching 63.9 percent in Q2 2023—the contribution from public consumption. highest level since 2019. Average private sector Private consumption grew by 3 percent in wage growth reached 9.5 percent in Q1 2023, Q1 2023 (yoy), supported by increasing down from 14.2 percent in Q4 2022, mainly employment and wages, strong consumer driven by wage increases in trade, transport, confidence, relatively low interest rates and accommodation, and public administration. benign credit conditions, despite of monetary In real terms, wages increased by 3 percent in policy normalization. Gross Fixed Capital Q1 compared with 6.3 percent in Q4 2022. Formation (GFCF) grew by 7 percent in Q1 Unemployment reached 10.7 percent in Q2 2023, reflecting higher public investment 2023, slightly higher than the end-2022 rate. compared with Q1 2022, but weaker private sector construction activity. Net exports of Inflation significantly reduced compared goods and services adversely affected GDP with its peak in 2022. The annual inflation growth: consumption growth supported an rate dropped to 4.0 percent in August increase in demand for imports in Q1 2023, 2023 from a record high of 8.3 percent which outpaced export growth. Leading in October 2022, as a result of downward Albania 65 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 pressures from lower import prices, domestic The Government’s fiscal position improved currency appreciation, and monetary policy in H1 2023. The Government recorded a high normalization. Upward pressure on inflation surplus on account of strong revenue collection included wage increases and high-capacity and lower spending. Grants accounted for utilization that kept production costs high. most of the revenue increase (14.5 percent yoy, Unprocessed foods contributed most to the owed to EU disbursements), alongside social increase in inflation, alongside increases in the insurance contributions and personal income price of services. Reflecting demand pressures, taxes, reflecting the increase in statutory core inflation averaged 5.5 percent in Q2 2023, minimum wages. The increase in expenditures down from 8 percent in Q1 2023. In contrast, was relatively small at 3.4 percent (yoy), non-core inflation reached 2.8 percent in Q2, but is expected to pick up during H2 2023 gradually converging to the pre-war average. In owing to increasing capital spending. With a 2023 the appreciation trend, which has been forecast deficit of 2.5 percent of GDP in 2023, accelerating since 2021, has continued, with public debt is expected to reach 63.1 percent the exchange rate appreciating by 12.1 percent of GDP in 2023, down from 65.4 percent of in July 2023. The trend reflects the gradual GDP in 2022. In line with the Government’s reduction in the current account deficit (CAD) Debt Management Strategy and the favorable and an improvement of external balances as a conditions for Albania, a Eurobond amounting result of growing services exports. On account EUR 600 million was issued in July 2023, to of domestic currency appreciation, monetary allow for the rollover of part of a Eurobond policy normalization was slower than expected; maturing in 2025. The rating for the country the central bank’s policy rate stood at 3 percent was confirmed at B1 by Moody’s in 2023. in August 2023, and has remained at this level since the last policy rate increase in March The CAD continued to narrow following 2023. strong growth in the export of services (by 38 percent), of which tourism experienced In the financial sector, despite increased growth of 52 percent and remittances of policy rates, credit to the private sector 16 percent. The CAD narrowed by 45.9 percent continued to support demand expansion. in Q1 2023 in nominal terms, reaching Credit growth to the private sector reached 3.1 percent of GDP. The primary income deficit 1.6 percent in June 2023 (yoy), slowing also narrowed by 6.7 percent during the same since end-2022 due to several factors, such as period, with labor incomes increasing by more higher rates, tightening of credit standards by than investment income outflows. Foreign banks, especially for businesses, and exchange direct investment (FDI) financed 195 percent rate appreciation. Similarly, bank deposits of the CAD and contributed to a build-up in continued to expand by 9.5 percent, with reserves. The reserve coverage at the end of Q1 household savings accounting for most of 2023 stood at 6.8 months of imports of goods increase in total deposits in the system. and services, and covered 3.3 times the short- term external debt. 66 Albania TOWARD SUSTAINABLE GROWTH Outlook and Risks Domestic risks emanate from natural disasters, public-private partnerships, and GDP growth is expected to moderate to state-owned enterprises, in addition to fiscal 3.6 percent in 2023, in the context of tight risks stemming from the country’s hydropower- global financial conditions and limited based energy sector that are mainly due to economic growth in Europe. Nevertheless, variations in hydrology. increased tourism and construction are expected to drive exports, consumption and investment growth at rates similar to the pre- pandemic period. Overall, the contribution to growth from investment is expected to decelerate, given the very high base effect and the completion of programs for post-earthquake reconstruction. The inflation rate is projected to start converging toward the 3 percent target by 2024. The primary balance is projected to reach 0.1 percent of GDP in 2023 and stay positive in observance of the fiscal rule. Fiscal consolidation is expected from the spending side. On revenues, the Government plans to introduce further tax policy measures, as envisioned in the Medium-Term Revenue Strategy. Public debt is expected to continue to decline over the medium term, as a result of higher nominal growth and a gradual improvement of the primary balance. Given Albania’s growing reliance on external financing, the exchange rate, interest rate, and refinancing related risks remain elevated. Further increases in food and energy prices are a key risk to growth, as they could affect real disposable income, slow poverty reduction, and potentially constrain the fiscal space. As a small, open economy, Albania is highly exposed to external shocks, such as recession in Europe or further tightening of financing conditions in international capital markets beyond the current year. Albania 67 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 GDP grew strongly in 2022 but the speed Labor markets are improving. of recovery moderated. ESI Real GDP growth (percent, yoy, not sa) Percent 140 25 70 14 120 20 13 15 60 100 12 10 80 11 5 50 60 10 0 40 -5 9 40 20 -10 8 0 -15 30 7 Au -17 Ja -17 Ju 18 No -18 Ap -18 Se -19 Fe -19 Ju 20 De -20 M -20 Oc -21 M t-21 Au -22 Ja -22 Ju 23 23 0 1 2 7 8 8 9 9 0 1 2 3 n- n- n- -2 -2 b- -1 -2 -2 -2 -1 -1 -1 -1 -2 -2 g ar ay p r n v g ar c l Q3 Q1 Q3 Q3 Q1 Q1 Q3 Q3 Q1 Q1 Q3 Q1 M J GDP growth (rhs) ▬ Economic Sentiment Index ▬ Labor force participation rate ▬ Employment rate ▬ Unemployment rate (rhs) Sources: INSTAT and Bank of Albania. Source: INSTAT. Public revenue growth outpaced the ...and the current account deficit expenditure growth… narrowed. Percent change, yoy Percent change, yoy 35 80 30 60 25 20 40 15 10 20 5 0 0 -5 -20 -10 -15 -40 -20 -60 M -18 Se -18 Ja 18 M -19 Se -19 Ja -19 M -20 Se -20 Ja 20 M -21 Se -21 Ja -21 M 22 Se -22 Ja -22 M 23 3 -2 Q2 19 Q3 19 Q4 19 Q1 19 Q2 20 Q3 20 Q4 20 Q1 20 Q2 21 Q3 21 Q4 21 Q1 1 Q2 22 Q3 22 Q4 22 Q1 2 3 p- n- n- p- -2 -2 -2 ay ay n p n p ay n ay ay p ay n - - - - - - - - - - - - - - Ja Q1 ▬ Public revenue ▬ Public expenditures Source: Ministry of Finance. Source: Bank of Albania. Credit to the private sector continues Headline and core inflation started to increasing, but at a slower pace. come down. Percent change, yoy Percent, yoy 12 10 10 8 8 6 6 4 4 2 2 0 0 -2 -4 -2 Ju -16 No -16 Ap -16 Se r-17 Fe -17 Ju 18 De l-18 M c-18 Oc -19 M t-19 Au r-20 Ja -20 Ju -21 No -21 Ap -21 Se r-22 Fe -22 Ju 23 3 M -18 Se -18 Ja 18 M -19 Se -19 Ja -19 M -20 Se -20 Ja 20 M -21 Se -21 Ja -21 M 22 Se -22 Ja -22 M 23 3 l-2 -2 b- b- p- n- n- p- p ay n n v n n v ay p ay n p n p ay n ay ay p g ay n a Ja Ja ▬ Inflation (CPI) ▬ Core inflation Source: Bank of Albania. Source: Bank of Albania. 68 Albania TOWARD SUSTAINABLE GROWTH ALBANIA Selected Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) -3.3 8.9 4.8 3.6 3.2 3.2 Composition (percentage points): Consumption -2.5 3.6 6.7 2.1 2.1 2.0 Investment -0.8 4.6 1.7 -0.3 0.8 0.8 Net exports 0.0 0.7 -3.6 1.8 0.3 0.4 Exports -9.4 13.0 2.6 2.4 2.0 2.2 Imports (-) -9.3 12.3 6.2 0.6 1.7 1.8 Consumer price inflation (percent, period average) 2.2 2.6 6.7 5.0 3.5 3.0 Public revenues (percent of GDP) 25.9 27.5 26.8 28.1 27.5 27.7 Public expenditures (percent of GDP) 32.6 32.1 30.5 30.6 29.9 29.6 Of which: Wage bill (percent of GDP) 4.7 4.5 4.0 4.5 4.7 4.7 Social benefits (percent of GDP) 13.4 12.3 11.6 11.5 11.1 11.2 Capital expenditures (percent of GDP) 6.2 6.9 6.6 5.3 5.2 5.2 Fiscal balance (percent of GDP) -6.7 -4.6 -3.7 -2.5 -2.3 -1.9 Primary fiscal balance (percent of GDP) -4.6 -2.7 -1.8 0.1 0.3 0.5 Public debt (percent of GDP) 73.0 71.5 62.1 60.3 59.4 58.5 Public and publicly guaranteed debt (percent of GDP) 75.8 75.4 65.4 63.1 62.1 60.8 Of which: External (percent of GDP) 35.2 36.8 30.3 29.8 29.3 27.8 Goods exports (percent of GDP) 6.0 8.3 10.8 9.3 9.3 9.3 Goods imports (percent of GDP) 28.4 33.6 34.6 31.1 30.9 30.8 Net services exports (percent of GDP) 8.1 11.7 13.4 12.1 11.8 11.8 Trade balance (percent of GDP) -14.3 -13.5 -10.4 -9.7 -9.8 -9.7 Net remittance inflows (percent of GDP) 5.1 5.0 5.5 5.4 5.4 5.4 Current account balance (percent of GDP) -8.5 -7.8 -6.0 -5.6 -5.8 -5.6 Net foreign direct investment inflows (percent of GDP) 6.7 6.5 6.7 6.8 6.8 6.8 External debt (percent of GDP) 60.5 62.7 54.3 51.8 50.0 49.0 Real private credit growth (percent, period average) 4.6 5.5 2.9 – – – Nonperforming loans (percent of gross loans, end of period) 8.1 5.7 5.0 – – – Unemployment rate (percent, period average) 11.7 11.5 11.0 – – – Youth unemployment rate (percent, period average) 20.9 20.9 20.7 – – – Labor force participation rate (percent, period average) 59.5 59.8 62.4 – – – GDP per capita, PPP (current international $) 14,888 16,302 16,782 17,151 17,734 18,515 Poverty rate (percent of population) 34.4 27.5 25.2 23.9 22.0 20.4 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: In annual percent change unless indicated otherwise. Poverty rate calculations based on ECAPOV harmonization using SILC-C data. Nowcasted/projected values start at 2019. Income measures in the SILC and consumption measures in the HBS are not strictly comparable. Poverty is defined as living on less than $6.85/day per person in revised 2017 PPPs. e = estimate; f = forecast; PPP = purchasing power parity; – = not available. Albania 69 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Bosnia and Herzegovina • With real GDP growth continuing to slow to 1.1 percent in Q1 2023 (yoy), economic activity in Bosnia and Herzegovina (BiH) is set to further decelerate to 2.2 percent in 2023. • Softer private consumption and a drop in transport prices should result in an inflation rate of 5.8 percent in 2023, a significant slowdown from 14 percent seen in 2022. • A sharp deceleration in exports is expected to broaden the external deficit somewhat to 4.7 percent of GDP in 2023. • The labor market is characterized by declining unemployment, particularly among women, although this is because fewer women were looking for jobs. • Stronger tax revenues supported by high inflation resulted in a fiscal surplus of 0.4 percent of GDP in 2022 but a return to a deficit is expected in 2023 in part due to municipal elections in 2024. • Real output growth is expected to improve to 2.8 percent in 2024 and 3.4 percent in 2025 as private consumption recovers, together with EU demand for BiH’s goods. • EU candidacy status received in December 2022 could serve as a catalyst for much-needed structural reforms. Quicker formation of entities’ governments following the October 2022 elections than in the previous cycle yields some confidence. Recent Economic Developments by an average after-tax real wage increase of 17 percent during the period January to June After surging to 7.4 percent in 2021, real 2023. The impetus on the demand side will be GDP grew by 3.9 percent1 in 2022, as the moderated, however, by the poor performance rebound from the post-pandemic period of industrial production on the supply side. subsided. Economic activity in 2022 slowed Specifically, industrial production dropped consistently from 5.9 percent in Q1 2022 (yoy) 3.9 percent during the period January–July to 1.7 percent in Q4 2022 (yoy), mainly due to 2023, largely driven by a fall in sales on foreign an output deceleration in manufacturing on the markets totaling 11 percent, whereas turnover supply side and a slowdown in final domestic in the domestic market declined 2 percent. consumption on the demand side. This trend of rapid deceleration persisted into Q1 2023, Net exports shrank by 0.3 percent of GDP with real GDP rising a mere 1.1 percent (yoy). in Q1 2023, a significant decline from The latter is primarily due to the contraction 6.7 percent of GDP posted in Q1 2022. in private consumption of 0.5 percent (yoy) as The compression in net exports is the result of remittance inflows dropped by 4.8 percent in an almost total standstill in both exports and real terms in Q1 2023. Meanwhile, gross capital imports. More precisely, exports slowed by formation grew by 12.6 percent (yoy), which 1.7 percent (real terms) in Q1 2023 from a partly offset the decline in private consumption. jump of 38.6 percent the previous year, while Nonetheless, private consumption is expected growth in imports dropped to 2 percent (real to pick up in Q2 and Q3 of 2023, supported terms) in Q1 2023 from a jump of 31.9 percent 1 BiH Agency for Statistics, Economic Statistics No.2 from 30.06.2023. 70 Bosnia and Herzegovina TOWARD SUSTAINABLE GROWTH one year ago. This net export performance point decline vis-à-vis Q1 2022.2 However, is driven by weaker demand from the EU, the decline in the unemployment rate was but also represents a base effect considering driven by people moving from employment the high growth rates in early 2022. On the into inactivity, rather than improvements in import side, lower growth is due to a decline employment itself. The overall activity rate in private consumption and, similar to the case declined by 1 percentage point during this of exports, represents a base effect due to high period. The decline in the unemployment import growth in Q1 2022. rate has been particularly pronounced among women, amounting to 4.1 percentage points During the period January–July 2023, between Q1 2022 and Q1 2023 compared with inflation amounted to 8.5 percent, a 2.8 percentage point decline among men, but 3.7-percentage-point drop vis-à-vis the same this was driven by a larger decline in the activity period in 2022. Inflation slowed to 4.0 percent rate among women. Furthermore, the female in July (yoy), a considerable slowdown from unemployment rate remains high compared 14.1 percent (yoy) seen in January 2023. with other Western Balkans countries. Inflation dynamics represent a confluence of stubbornly high food prices, together with high Stronger tax revenues supported by a high prices of housing, water, electricity, and gas on inflation rate were not offset by higher the one hand, and sharply declining transport nominal public spending, which resulted prices on the other hand. Food prices grew in a fiscal surplus of 0.4 percent of GDP by 15.5 percent during January–July 2023 in 2022.3 This compares with a deficit of compared with a rate of 19.3 percent during 0.3 percent of GDP in 2021, and 5.2 percent the same period in 2022. Meanwhile, transport of GDP in 2020. The fiscal surplus is the result prices declined 12.7 and 13.2 percent in June of a fiscal surplus in the Federation BiH and and July of 2023 (yoy), respectively, which a fiscal deficit in RS. Expenditures in 2022 in translated into a negative rate of 2.9 percent both entities were driven by social measures during January–July. As the impact of lower softening the inflationary impact on households transport prices exerts downward pressure on and pre-election spending, including wage input costs, and spreads through the economy, and pension hikes, as well as higher capital the inflation rate is likely to decelerate to expenditures. However, spending in the RS 5.8 percent in 2023. compared with the Federation was much higher on wage increases, pension outlays, and Key labor market indicators remain static. social assistance, in GDP terms. Gross public The overall employment rate (ages 15–89) debt in BiH remains sustainable at just below increased marginally to 40.8 percent in Q1 30 percent of GDP.4 2023 compared with 40.1 percent in Q1 2022, while the unemployment rate (ages 15–74) shrank to 13.3 percent, a 3.4-percentage- 2 The methodology of the Labor Force Survey was changed in 2021, which makes direct comparisons between 2021 and 2020 data difficult. 3 BiH Global Fiscal Framework for 2022–2024 and World Bank staff estimates; estimates for H1 2023 by CBBiH are expected by end-September 2023. 4 Central Bank of BiH 2023 (data available at Panorama web portal), World Bank staff calculations. Bosnia and Herzegovina 71 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 The current account deficit (CAD) widened to 3.6 percent of GDP, a 1.6-percentage-point to 4.5 percent in 2022 from 2.4 percent increase compared with the same period in of GDP in 2021, driven by a rise in the 2022. merchandise trade deficit. The merchandise trade deficit rose by 3.8 percentage points to The banking sector is well-capitalized and 22.1 percent of GDP in 2022, and was driven profitable. Banks are liquid, and profitable, by high import prices of fuel, food, and other with non-performing loans (NPLs) at their commodities, amid strong domestic demand. lowest level in a decade (4.1 percent in Q2 Higher goods imports growth (13.1 percent) 2023). There have been no direct spillovers more than offset higher growth in goods from financial stress in advanced economies exports (8.8 percent), which was also driven by due to the limited reliance on international and higher prices, notably of metals and electricity. wholesale funding, and fixed-income assets of Exports of goods were helped by stronger BiH banks. services exports due to a recovery in tourism. BiH’s 5.8 percent of GDP in travel inflows in 2022 exceeded pre-pandemic-level inflows, Outlook and Risks which had come to 3.2 percent in 2019. The contribution of net remittances remained Real output growth in BiH is estimated to the same as in 2021, totaling 7.8 percent decelerate further to 2.2 percent in 2023 of GDP, while the primary income balance driven by slower private consumption and improved. After capital account adjustments, exports. In the medium term, real GDP the CAD amounted to 3.8 percent of GDP growth is projected at 2.8 percent in 2024, and in 2022, two-thirds of which were financed 3.4 percent in 2025, as private consumption by net FDI inflows, which were equivalent regains momentum driven by a strengthening to 2.5 percent of GDP. Portfolio investment of real disposable income. Inflation is expected outflows of 0.4 percent of GDP were more to stabilize in 2024–25 at around 2 percent than offset by other investment inflows of per year on the back of lower transport prices, 0.9 percent of GDP. The latter was dominated and in line with inflation rates prior to the by trade credits, whereas net disbursements on pandemic. Stronger exports on the back of a government loans dropped significantly. gradual growth recovery in the EU are likely to be offset by higher imports of consumer Preliminary data suggest an improvement goods, resulting in a further widening of the in the CAD as the merchandise trade deficit CAD from 4.7 percent of GDP in 2023 to in Q1 2023 narrowed and the services 5.1 percent by 2025. surplus widened. This resulted in an external account deficit of 3.6 percent of GDP in The return to fiscal surplus in 2022 is likely Q1 2023 compared with 4 percent in Q1 to be short-lived due to the upcoming 2022. Nevertheless, as private consumption municipal elections in 2024. An overall strengthens, the CAD is expected to widen higher wage bill, pension outlays, and social marginally to 4.7 percent of GDP. This should benefits are expected in 2023 and 2024, be largely financed by net FDI inflows, which since governments’ measures in 2022 were improved significantly in Q1 2023 amounting permanent. This spending will further 72 Bosnia and Herzegovina TOWARD SUSTAINABLE GROWTH increase as part of the municipal pre-election expenditure cycle. Nevertheless, by 2025 the fiscal stance is expected to be balanced again. Public debt is projected to remain sustainable at below 30 percent of GDP during 2023– 2025, although debt levels vary significantly across the two entities. With general elections completed in October 2022, and entities’ governments formed, it would be opportune for policy makers to turn to the structural reform agenda and the fulfillment of legislative priorities for EU accession. In this respect, three of 14 required legislative steps—which are part of the often-referenced European package—have been passed recently by parliaments. These laws define free access to information at the level of BiH, address human rights, and define the role of courts. Downside risks dominate the outlook. Protracted market disruptions following the pandemic and uncertainties fanned by the war in Ukraine could have a negative impact on aggregate demand through depressed consumer and business confidence. Furthermore, the recovery in the EU remains fragile, potentially adversely impacting demand for BiH exports, except for energy. A weaker labor market across the EU, most specifically in Germany, could limit remittance inflows, which support private consumption. Finally, geopolitical risks could further aggravate domestic political frictions with adverse consequences for the much- needed structural reform push. Bosnia and Herzegovina 73 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 GDP growth is expected to slow in 2023 Post-crisis growth trajectory is unlikely to close the gap with pre-crisis growth path. Contributions to growth, percentage points of GDP In 2015, thousand KM 8 41 39 6 37 4 35 2 33 31 0 29 -2 27 -4 25 2019 2020 2021 2022e 2023f 2024f 2025f 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 J Agriculture J Industry J Services Q GDP growth (percent) ▬ GDP pre-pandemic … GDP post-pandemic Sources: BiH Agency for Statistics; World Bank. Source: World Bank staff estimates. Note: e = estimate; f = forecast. Consumer price and food inflation ...while the fiscal deficit is expected to continue their downward trend in Q1 widen in 2023, despite higher revenues 2023... due to inflation. CPI, percent yoy General government fiscal balance, percent of GDP 20 3 2 16 1 12 0 -1 8 -2 4 -3 0 -4 -5 -4 -6 17 De 8 18 De 9 19 De 0 20 De 1 Ju 1 De 2 22 23 16 17 18 19 20 21 e f 2 2 2 1 1 2 23 c- 22 n- c- n- c- n- c- n- c- n- n- c- 20 20 20 20 20 20 20 De 20 Ju Ju Ju Ju Ju Sources: BiH Agency for Statistics; World Bank. Sources: BiH fiscal authorities; World Bank staff estimates. The merchandise trade deficit widened. Nonperforming loans in commercial bank portfolios have decline steadily. Real 3-month moving average (3mma), percent yoy 60 20 50 18 40 16 30 14 20 12 10 10 0 8 -10 6 -20 4 -30 2 -40 0 M -18 Se -18 Ja 18 M -19 Se -19 Ja -19 M 20 Se -20 Ja 20 M -21 Se -21 Ja -21 M -22 Se -22 Ja 22 M 23 3 -2 Q 3 15 Q1 15 Q3 16 Q1 16 Q3 17 Q1 7 Q 3 18 Q1 8 Q3 19 Q1 9 Q3 20 Q1 0 Q3 21 Q1 1 Q3 22 Q1 2 3 p- p- n- n- p- ay -2 ay n p -1 n p ay n -2 ay -2 ay n -1 -1 -2 ay - - - - - - - - - - Ja Q1 ▬ Exports ▬ Imports ▬ Trade deficit J Capital adequacy (tier 1 capital to risk weighted assets) ▬ Asset quality (NPLs to total loans) ▬ Profitability (return on equity) Sources: BiH Indirect Tax Office; World Bank. Sources: Central Bank of BiH; World Bank calculations. 74 Bosnia and Herzegovina TOWARD SUSTAINABLE GROWTH BOSNIA AND HERZEGOVINA Selected Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) -3.0 7.4 3.9 2.2 2.8 3.4 Composition (percentage points): Consumption – – 2.7 1.9 2.2 2.6 Investment – – 3.5 1.9 0.7 0.4 Net exports – – -2.3 -1.6 -0.1 0.5 Exports – – 3.5 1.5 2.1 2.3 Imports (-) – – 5.8 3.1 2.2 1.9 Consumer price inflation (percent, period average) -1.1 2.0 14.0 5.8 2.5 0.9 Public revenues (percent of GDP) 41.6 41.1 40.1 40.7 41.0 41.5 Public expenditures (percent of GDP) 46.8 41.3 39.7 41.5 40.9 41.5 Of which: Wage bill (percent of GDP) 11.3 10.3 10.3 10.8 10.6 10.3 Social benefits (percent of GDP) 15.9 14.6 17.4 17.7 18.6 19.2 Capital expenditures (percent of GDP) 5.1 3.5 3.5 3.7 3.1 3.4 Fiscal balance (percent of GDP) -5.2 -0.3 0.4 -0.8 0.0 0.0 Primary fiscal balance (percent of GDP) -4.5 0.3 1.0 0.1 0.9 0.9 Public debt (percent of GDP) 36.1 34.0 29.3 27.6 27.0 26.3 Public and publicly guaranteed debt (percent of GDP) 38.8 37.6 31.5 29.5 29.2 28.5 Of which: External (percent of GDP) 30.4 29.5 24.9 23.3 22.6 22.0 Goods exports (percent of GDP) 27.1 32.5 35.4 36.9 36.4 35.8 Goods imports (percent of GDP) 45.2 50.8 57.5 59.0 58.0 57.5 Net services exports (percent of GDP) 4.3 6.6 7.9 8.2 7.7 7.3 Trade balance (percent of GDP) -13.7 -11.8 -14.2 -13.9 -14.0 -14.3 Net remittance inflows (percent of GDP) 7.3 7.8 7.8 7.4 7.2 7.1 Current account balance (percent of GDP) -3.2 -2.4 -4.5 -4.7 -4.8 -5.1 Net foreign direct investment inflows (percent of GDP) 1.8 2.3 2.5 2.4 2.4 2.3 External debt (percent of GDP) 69.7 62.4 60.5 60.0 59.1 57.4 Real private credit growth (percent, period average) 1.3 -0.3 -8.1 – – – Nonperforming loans (percent of gross loans, end of period) 6.1 5.8 5.4 – – – Unemployment rate (percent, period average) 15.9 17.4 15.4 – – – Youth unemployment rate (percent, period average) 36.6 38.2 35.0 – – – Labor force participation rate (percent, period average) 47.7 48.0 47.6 – – – GDP per capita, PPP (current international $) 15,337 17,377 17,898 18,345 18,896 19,557 Sources: Country authorities, World Bank estimates and projections. Note: e = estimate; f = forecast; PPP = purchasing power parity; – = not available. Bosnia and Herzegovina 75 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Kosovo • Amidst challenging external conditions, real GDP growth decelerated but remains positive; economic activity is expected to expand by 3.2 percent during 2023. • Positive performance of service exports and private consumption were key growth drivers. • Inflation has been steadily decreasing from its peak of 14.2 percent in July 2022, but price pressures remain heightened; annual consumer inflation averaged close to 6 percent between January and August 2023. • Although the outlook remains positive, the balance of risks remains tilted to the downside. Continued uncertainties related to the war in Ukraine, a further slowdown of economic activity in Europe, and the complexity of the political environment, represent significant risks. Recent Economic Developments Inflation has been steadily decreasing from its peak of 14.2 percent in July 2022, but Kosovo’s macroeconomic conditions price pressures remain elevated. Consumer remained favorable during H1 2023, inflation averaged 6 percent between January despite persistent external volatility and and August 2023, and inflation decelerated a slowdown in growth in Q2. During to 2.4 percent by July 2023, but experienced Q2 2023, real economic activity reached a slight uptick in August 2023 (3.2 percent). 2 percent year-on-year (yoy)5, bringing H1 During this period, a significant contribution 2023 growth to 2.9 percent. Growth in Q2 to inflation resulted from price increases of was primarily driven by a 5.9 percent real furnishing, household items and maintenance increase in exports thanks to record growth in (7.2 percent), alcoholic beverages and tobacco exports of services (13.6 percent); mostly in (6.3 percent), and food and non-alcoholic diaspora-related travel services, as well as ICT beverages (5.5 percent). Transport prices— services. Exports of goods, contrary to initial which contributed to inflationary pressures expectations, contracted by 10.7 percent in real in 2022—subtracted from the inflation rate terms. Private consumption and gross capital (-3.8 percent). At 4 percent in August, core formation witnessed moderate growth of 3.7 inflation also went up, and remains higher than and 2 percent, respectively. On the production overall inflation. Prices of imports continued to side, services provided the highest contribution increase, but at a decelerating trend, impacted to growth. Monthly indicators, including primarily by a drop in commodity and energy those on the external sector, firm sales and import prices. Meanwhile, both producer and international travel data, show that the impact agricultural input prices declined compared from consumption and service exports on with H1 2022. growth was strong throughout the first three quarters of the year. Employment and employment formalization are on the rise, but the labor market continues to face critical challenges. According to recent 5 All references hereon refer to year on year comparisons, unless otherwise indicated. 76 Kosovo TOWARD SUSTAINABLE GROWTH administrative data, formal employment 14.3 percent by June 2023. Nonetheless, FDI increased by 2.8 percent between August remains highly concentrated in the construction 2022 and August 2023.6 The latest Labor and the real estate sector, reflecting the demand Force Survey (LFS)7 revealed that the working of the Kosovar diaspora for real estate assets in age population shrank during 2022, possibly Kosovo. due to migration, while the employment- to-population ratio experienced an increase, The overall fiscal balance remained within from 31.1 percent in 2021 to 33.8 percent in fiscal rule limits. For January–August 2023, 2022. Notably, the unemployment rate has and in line with the seasonality of budget been on a downward trajectory, plummeting expenditures, the Government ran a surplus, to 12.6 percent in 2022; but inactivity rates slightly above 2022 levels. For the same period, remain high. The LFS data further highlight tax revenues grew by 12 percent while overall prominent gender disparities within the labor revenues increased by 15 percent, boosted market, encompassing significant differences in also by energy-related EU on-budget grants employment rates (49.4 percent for males and worth EUR 67.5 million. Direct taxes and 18.4 percent for females in 2022), inactivity domestically collected VAT increased by close rates (45 percent for males and 78 percent for to 20 percent, while VAT and excises collected females), as well as moderate levels of youth at the border (representing more than half of unemployment (21.4 percent). Kosovo has tax revenues) increased by around 6 percent no official statistics on open vacancies, but each. Expenditures, on the other hand, individual surveys from business organizations increased by 16.2 percent until August 2023. show increasing challenges for firms in filling Implementation of the new legislation on public vacancies, particularly for qualified employees. wages has led to a 20 percent increase of the monthly wage bill. Given the discontinuation of By June 2023, the current account deficit energy import subsidies, together with a drop in (CAD) showed signs of improvement, the number of beneficiaries for several pension driven by lower value imports coupled with schemes and the social assistance program, total a continued positive performance in service spending on subsidies and transfers declined exports and secondary income inflows. slightly by 1 percent. In July 2023, Parliament Nominal merchandise exports and imports amended the state pension legislation which dropped by 8.1 and 5.2 percent, respectively. will increase average pension benefits, likely The service trade balance increased further with a significant future fiscal impact. Capital improved by 36 percent as of June 2023. expenditure increased by 77 percent by Hence, the trade deficit slightly decreased by August 2023, albeit from the relatively low 1.8 percent during this period. By August 2023, base of 2022. Despite the significant pick up remittances recorded a cumulative growth rate in spending, implementation of externally of 11.7 percent. Foreign direct investment financed capital projects continues to lag. (FDI) continued to experience a positive Implementation of additional energy-related performance with a cumulative increase of subsidies and seasonally higher payments for 6 Administrative Labor Market Statistics, August 2023, Kosovo Statistics Agency. 7 Kosovo has large delays in publishing Labour Force Survey (LFS) data, and as of today only 2022 data are available. Kosovo 77 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 capital projects are expected to lead to a modest buffers and asset quality remain positive. The fiscal deficit by year end slightly higher than the ratio of regulatory capital on risk-weighted previous year’s fiscal deficit. assets stood at 15.6 percent in August 2023 and nonperforming loans remained at 2 percent. Since January 2023, total public and publicly guaranteed (PPG) debt has been on a downward trend. By end Q2 2023, PPG Outlook and Risks debt stood at 17.3 percent of GDP, down from 19.9 percent of GDP at end-2022. In 2023, Despite continued inflationary pressures, the Government has amortized more than Euro real GDP growth is expected to reach 120 million of domestic debt. On the other 3.2 percent in 2023, driven by positive hand, external debt continued to increase at a export performance and higher private moderate pace, but at less than half the level consumption. Higher services exports are of the reduction in the stock of domestic debt. expected to offset stalling merchandise exports During H1 2023, the Government reached a and increasing imports, leading to a positive real Precautionary Stand-By-Arrangement (around contribution of the external balance to growth. EUR 100 million) and an Arrangement Under At the same time, strong credit growth and higher the Resilience and Sustainability Facility net remittances, supported by elevated levels of with the IMF (around EUR 78 million). As public transfers, are expected to support private of September 2023, no disbursemnts under consumption. Higher public wage spending these programs have taken place. Lastly, following the implementation of the new the Government decided to commence the Law on Public Wages, coupled with increased repayment of pension savings fund withdrawals public spending on maintenance and services, authorized in 2020, as part of its pandemic is expected to support public consumption liquidity support measures. growth. Likewise, after contracting in 2022, gross fixed investment is expected to add to Increases in the cost of borrowing have not growth, fueled by construction activity and a reduced credit demand. By August 2023, more predictable environment for input prices. total bank credit increased by 13.2 percent Public capital expenditure is also expected (8.3 percent for new loans), with total loans to boost investment on the heels of recent to households increasing by 16.9 percent. The efforts to lift implementation bottlenecks, microfinance loan portfolio, which represents including through price adjustments for public less than 10 percent of the bank credit portfolio contracts. On the production side, services are but provides services to a significant number expected to provide a higher contribution than of citizens, increased by close to 24 percent. manufacturing and agriculture combined. Concurrently, deposits grew by 12.2 percent. The cost of funding increased by approximately The medium-term outlook remains positive 0.6 of a percentage point on average, in the within a context of high uncertainty. The period January–August 2023 with respect contribution of investment to growth is to the same period in 2022. Average interest expected to pick up in 2024–2025, supported rates on new loans increasing, for example, by increased investment in public infrastructure, increased from 5.9 to 6.5 percent. Capital including through the support of external 78 Kosovo TOWARD SUSTAINABLE GROWTH financing, and higher public and private expected to improve by 4 percentage points of investments in energy supply and efficiency. GDP owing to a deceleration in imports and However, despite expected improvements in further improvements in the services balance. capital execution, public investment is expected Over 2024–25, the CAD is expected to further to remain below budgeted levels. Based on the decline on account of improvements in the trade permitting pipeline, real estate development balance, albeit at a much slower pace. Non-debt activity is expected to continue boosting creating FDI inflows are expected to continue investment and growth in the medium term. providing the main source of financing for the Financial deepening and primary and secondary CAD, but high levels of errors and omissions inflows are expected to support consumption, in the balance of payments remain a source of coupled with higher pension transfers in 2024. uncertainty. Over-concentration of FDI on real Reactivation of Kosovo’s ferronickel production estate activities is expected to continue over the capacities is expected to boost merchandise medium term, but higher energy sector private exports. With growth expected to accelerate investment could potentially lead to higher toward 4 percent, the level of economic activity diversification of FDI. should converge toward Kosovo’s potential. Yet, continued uncertainties related to the war The fiscal deficit is estimated to remain in Ukraine and the impact on the energy sector below 1 percent of GDP in 2023, driven in Kosovo, a further slowdown of economic by positive tax revenue performance and activity in Europe, and a deterioration of the lower-than-budgeted capital expenditures. domestic political context, represent significant Over the medium term, the deficit should on risks. average represent between 1.5 and 2.0 percent of GDP on the back of an increase in capital Inflation is expected to decelerate, but price spending associated to the Energy Strategy, pressures remain high. While decreasing in further increases in the public wage coefficients line with international trends, consumer price and operationalization of allowances in inflation is projected to reach 4.8 percent 2024, and higher spending on pensions. Tax in 2023 and further decelerate over 2024– revenues are expected to continue increasing, 2025, reflecting expectations on Euro area albeit at a slower rate than 2021–2023 given inflation and international commodity price the fading impact of inflation, particularly movements. A tighter labor market could, on border levied taxes. Implementation of however, exert an upward pressure on inflation. 2023 amendments to personal income tax At the same time, Kosovo’s high dependency (PIT) legislation increasing the non-taxable on imports continues to expose the country to PIT bracket to the level of the minimum international price fluctuations. Higher fuel wage—currently pending constitutional court and energy prices could lead to an inflation review—could further slow down the pace of rebound and an energy supply shock, negatively revenue collection. Until 2025, public debt is impacting growth. projected to remain below 20 percent of GDP, given historic bottlenecks to implementing After a significant deterioration over 2020- International Financial Institutions (IFI)- 2022, the CAD is expected to improve over financed capital projects. the medium term. In 2023, the CAD is Kosovo 79 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Further financial deepening has the potential to support credit growth, private consumption, and investment over the medium term. Envisaged legal changes to payments legislation could further boost digitalization of payments, also enhancing formalization. External private debt, which includes intercompany loans and trade credit, should also be on the rise. Moving forward, Kosovo needs to enhance resilience to external shocks while advancing structural reforms to unlock higher potential growth and speed up convergence with comparable EU peers. Since the outbreak of the COVID-19 pandemic, prudent macro- fiscal management has allowed Kosovo to respond to the impacts of the crisis. However, closing the gap with EU peers will require maintaining macroeconomic stability while addressing long-standing structural bottlenecks that limit potential output. Timely and effective implementation of the new Energy Strategy while safeguarding fiscal adequacy is imperative in this regard, alongside the need to reduce other infrastructure gaps in water, waste, and connectivity. Improvements of labor market outcomes can no longer be delayed and should focus on supporting greater inclusion of inactive women into the labor market, by reducing barriers to participation, also by scaling up access to childcare services. Furthermore, scaling up human capital investments—as a precondition to unlock higher potential growth—while preserving fiscal adequacy, requires effective and comprehensive reforms, such as: (i) optimizing the school network; (ii) setting up a health financing framework that promotes universal health coverage; and (iii) enhancing targeting of social assistance and the predictability and adequacy of pensions. 80 Kosovo TOWARD SUSTAINABLE GROWTH Investment bounced back, providing Service exports continued to increase, a modest but positive contribution to driven by travel, but also ICT and growth in 2023. business services. Contributions to growth, percentage points Service exports by category, in EUR million 12 2,500 9 2,000 6 1,500 3 1,000 0 -3 500 -6 0 2020 2021 2022 2023e 2024f 2025f 2019 2020 2021 2022 J Consumption J Investment J Net exports ▬ Growth (percent) J Travel J Other business services J Transport J Other J Telecommunications, computers and information services Sources: Kosovo Statistics Agency; World Bank staff calculations. Source: Central Bank of Kosovo. The fiscal deficit remains moderate. Inflationary pressures started to ease in 2023. Percent of GDP yoy changes, percent 35 8 15.0 30 6 12.5 4 25 10.0 2 20 7.5 0 -0.4 -0.6 5.0 15 -1.3 -2 -4 2.5 10 -6 0 5 -7.6 -8 -2.5 0 Ap 20 Ju 0 Oc 0 Ja 0 Ap 21 Ju 1 Oc 1 Ja 21 Ap 22 Ju 2 Oc 22 Ja 22 Ap 23 Ju 3 3 -10 2 l-2 2 2 l-2 2 l-2 2 n- r- t- n- r- l- t- n- r- n- r- t- 2020 2021 2022 2023e Ja J Public revenues J Public expenditure J Capital expenditure ▬ HICP inflation ▬ Core inflation J Current expenditure ▬ Budget deficit (rhs) Sources: Ministry of Finance; World Bank staff calculations. Sources: Kosovo Statistics Agency and Central Bank of Kosovo. Employment is gradually trending The financial sector remained stable. upwards. Total employment by LFS, in thousands Key financial soundness indicators, in percent 450 40 400 35 350 30 300 25 250 20 200 15 150 10 100 5 50 0 0 Ju 18 No l-18 M -18 Ju 19 No l-19 M -19 Ju 20 No l-20 M -20 Ju 21 No l-21 M -21 Ju 22 No 22 M -22 Ju 23 3 l-2 Q3 6 Q1 6 Q3 7 Q1 7 Q3 8 Q1 8 Q3 9 Q1 9 Q3 0 Q1 0 Q3 1 Q1 1 Q3 2 2 - - - - - - - -2 -2 -1 -1 -2 -2 -1 -1 -1 -1 ar v -1 -1 ar v -2 -2 ar v ar l v ar ar v Q1 M ▬ Capital adequacy ratio ▬ Liquidity ratio ▬ NPLs (eop) Source: Kosovo Statistical Agency. Source: Central Bank of Kosovo. Note: eop = end-of-period; NPLs = nonperforming loans. Kosovo 81 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 KOSOVO Selected Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) -5.3 10.7 5.2 3.2 3.9 4.0 Composition (percentage points): Consumption 2.1 8.2 3.9 2.3 3.4 3.4 Investment -2.8 5.0 -1.2 0.4 1.3 1.3 Net exports -4.7 -2.4 2.6 0.5 -0.8 -0.7 Exports -8.3 16.4 6.4 3.8 2.2 2.3 Imports (-) -3.6 18.8 3.9 3.3 3.1 3.0 Consumer price inflation (percent, period average) 0.2 3.4 11.6 4.8 3.0 2.5 Public revenues (percent of GDP) 25.4 27.4 27.8 28.7 28.2 28.3 Public expenditures (percent of GDP) 33.0 28.8 28.2 29.2 30.1 30.1 Of which: Wage bill (percent of GDP) 9.8 8.4 7.3 7.9 7.5 7.5 Social benefits (percent of GDP) 7.7 7.3 7.2 6.4 6.5 6.2 Capital expenditures (percent of GDP) 5.6 5.3 4.7 5.6 6.3 6.8 Fiscal balance (percent of GDP) -7.6 -1.3 -0.4 -0.6 -1.9 -1.9 Primary fiscal balance (percent of GDP) -7.2 -0.9 0.0 -0.2 -1.6 -1.3 Public debt (percent of GDP) 22.0 21.2 19.6 18.5 19.3 19.8 Public and publicly guaranteed debt (percent of GDP) 22.4 21.6 19.9 18.6 19.5 20.1 Of which: External (percent of GDP) 7.8 7.3 7.2 7.3 8.2 8.6 Goods exports (percent of GDP) 7.0 9.5 10.4 8.8 9.0 9.2 Goods imports (percent of GDP) 45.0 54.3 58.4 54.5 53.6 53.7 Net services exports (percent of GDP) 5.8 13.0 15.4 16.6 16.3 16.8 Trade balance (percent of GDP) -32.2 -31.8 -32.6 -29.1 -28.3 -27.7 Net remittance inflows (percent of GDP) 14.0 14.1 13.3 13.7 13.6 13.5 Current account balance (percent of GDP) -7.0 -8.7 -10.5 -6.5 -6.0 -5.5 Net foreign direct investment inflows (percent of GDP) 4.2 4.0 6.7 6.7 6.7 6.7 External debt (percent of GDP) 36.9 37.6 38.2 38.4 39.0 39.9 Real private credit growth (percent, period average) 7.6 7.5 5.2 – – – Nonperforming loans (percent of gross loans, end of period) 2.5 2.3 2.0 – – – Unemployment rate (percent, period average) 25.9 20.7 12.6 – – – Youth unemployment rate (percent, period average) 49.1 38.0 21.4 – – – Labor force participation rate (percent, period average) 38.3 39.3 38.6 – – – GDP per capita (US$) 4,321 5,270 5,305 5,810 5,804 6,758 Poverty rate (percent of population) 32.4 27.0 25.4 23.6 22.2 20.3 Sources: Country authorities; World Bank staff estimates and projections. Note: Poverty rate calculations based on ECAPOV harmonization using Household Budget Survey (HBS) data. Nowcasted/projected values start at 2018. Income measures in the SILC and consumption measures in the HBS are not strictly comparable. Poverty is defined as living on less than US$6.85/day per person in revised 2017 PPP. e = estimate; f = forecast; PPP = purchasing power parity; – = not available. 82 Kosovo TOWARD SUSTAINABLE GROWTH Montenegro • Montenegro’s growth remains strong and is estimated at 4.8 percent for 2023, driven by private consumption and service exports. • The fiscal performance has been better than planned, largely owing to one-off revenues and capital budget under-execution. • As Montenegro approaches large debt repayments during 2024–27, it requires very careful fiscal and debt management with well-designed policies affecting the fiscal position. Recent Economic Developments record high of 55.9 percent in Q2 2023 from 50.7 percent a year ago. The activity rate rose to The economy made a very strong start a record high of 64.2 percent from 59.3 percent in 2023. GDP expanded by 6.68 percent a year ago, while the unemployment rate in H1, driven by personal consumption, declined to a historical low of 12.9 percent underpinned by an increase in public sector from 14.6 percent. The youth unemployment wages, employment gains, and household rate also declined to its lowest ever at 17 percent borrowing. In the first seven months of in Q2 2022 from 26.7 percent. 2023, total international tourism overnight stays increased by 50 percent, outpacing by Administrative data suggest employment nearly a third the levels observed in the same also increased in early Q3 2023. In July, total period of 2019. Surging tourism, along with registered employment increased by 9.6 percent rising employment and an increase in wages, to reach a record high of 258,024 employed. supported retail trade, which expanded by In the first seven months, all sectors registered 10.4 percent in real terms over the same average employment growth, with the ICT period. Despite declining manufacturing due sector surging by 43.6 percent, also affected to a halt in aluminium production, industrial by migrant workers registering businesses in production increased by 5.4 percent in the Montenegro. The registered unemployment first seven months of 2023, due to favourable rate in July 2023 declined by 3 percentage hydrometeorological conditions earlier in the points to a historic low of 13.1 percent. year that affected electricity generation. While construction declined by 3.4 percent in H1 Inflation has eased but remains elevated. 2023,9 an increase in the number of building While annual inflation moderated to permits issued points to a likely resumption of 10.1 percent over the first eight months of construction activity in the near term. 2023, monthly inflation remains elevated, led by food prices. Montenegro’s food prices Strong employment gains of 2022 continued have not followed the trend of softening of into 2023, reflecting the year’s strong start. global food prices and most inflation remains The Labour Force Survey shows that average explained by increases in the prices of food employment increased by 10.7 percent in H1 and non-alcoholic beverages (14.7 percent) 2023. The employment rate thus rose to a and solid fuels (23.5 percent). Over the 8 All comparisons are year-on-year, unless otherwise indicated. 9 Measured as the number of effective hours worked on construction sites. Montenegro 83 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 same period, net average wages increased by of 5.7 percent. Net FDI fell by 26.4 percent, 11 percent in nominal terms, leading to an financing just half of the CAD, the remainder increase of 0.5 percent in real terms. However, being financed from reserves. In July 2023, this increase was almost entirely driven by international reserves stood at EUR 1.6 billion, public sector wages, while real wages declined covering five months of merchandise imports. in all other sectors, with the exceptions of ICT, construction, and mining. During 2023, the fiscal performance has been much better than expected. By July, The financial sector maintains strong capital the central government achieved a fiscal and liquidity buffers. In August 2023, surplus of 2.3 percent of GDP, due to strong outstanding loans were up by 8.9 percent, revenues and capital budget under-execution. driven by lending to households and non- The surge in revenues of 24.5 percent was residents. At the same time, overall deposits greatly supported by one-off payments (for the were up by 13.6 percent, led by the corporate economic citizenship program, a hedging fee, and household sectors. In the first eight and grants) equivalent to 1.8 percent of GDP, months, amid increasing interest rates, new but also solid corporate income tax (CIT) and loans declined by 6.4 percent but outpaced by contributions collection. The VAT and excise 17.6 percent new lending in the same period of collection was also strong. Expenditure growth 2019. The average capital adequacy ratio was a at 12.9 percent was more moderate than that healthy 20.1 percent in June 2023, well above of revenues, as capital spending declined by the regulatory minimum, while nonperforming 54.6 percent, despite an increase in public loans declined to 6.1 percent of total loans sector wages and social spending. While there from 6.9 percent in June 2022. Liquidity is are political pressures to increase spending, ample, with liquid assets over total assets stood Montenegro’s fiscal space is limited, and new standing at 25.7 percent in June 2023. While spending commitments should be consistent the financial sector is stable, at a time of rising with the need to reduce the deficit and debt. global interest rates and rapid credit growth, it is important to closely monitor the risks. Despite public debt falling as a share of GDP, it still presents a vulnerability. Montenegro’s The external imbalances have narrowed public debt declined from 69.3 percent of slightly in H1 2023. The current account deficit GDP in 2022 to an estimated 61.3 percent of (CAD) narrowed slightly, as export growth of GDP in June 2023, owing to a larger nominal 26.7 percent outpaced import growth of 15.1 GDP (that is, a denominator effect), negative percent. Export growth was primarily led by net borrowing, and a much better than planned tourism revenues which surged by 90 percent, fiscal performance. Subsequently, the stock of while merchandise exports slowed down in Q2 central government deposits increased from 2023, as the aluminium plant KAP stopped 1.9 percent of GDP in 2022 to 3.9 percent production. Still strong demand and higher of GDP in June 2023. However, the tighter food prices accounted for import growth, but global credit conditions imply a far higher cost this moderated in Q2 2023. Net primary and of financing for Montenegro, as evidenced in secondary income accounts strengthened only March 2023, when Montenegro borrowed marginally, despite a decline in net remittances EUR 100 million from Deutsche Bank, at 84 Montenegro TOWARD SUSTAINABLE GROWTH a variable interest rate composed of the six- fiscal deficit of 2 percent of GDP in 2023, the month Euribor reference rate and an interest fiscal deficit is expected at 3.9 and 3.6 percent margin of 5.9 percent per year. of GDP in 2024 and 2025, respectively. This is due to a recovery in capital spending and Montenegro’s political setting remains high levels of the wage bill and social spending. fragile. Since a major political change in Fiscal consolidation measures would, however, 2020, Montenegro’s political and institutional result in a better fiscal performance. Given landscape has been complex and fragile, the tightening of global financial conditions resulting in a vote of no-confidence in two and Montenegro’s sizable financing needs governments in one year. The new political over 2024–25, cautious fiscal management party, Europe Now, won the most seats in the is needed, particularly with respect to snap elections that took place in June 2023 expenditures, including implementing the and is tasked with forming a government. pension and public administration reforms. The political consensus focused on structural reforms, the rule of law, and fiscal prudence Significant debt repayments are due in will be critical to safeguard and improve 2024-25. Montenegro’s debt amortization development prospects of Montenegro in a in 2024 and 2025 is at an estimated 7.1 and very uncertain environment. 11.7 percent of GDP, respectively. Owing to stock-flow adjustments, public debt is expected to increase from 62.1 percent of GDP Outlook and Risks in 2023 to 66.1 percent of GDP in 2024, before declining to 62.3 percent of GDP in Montenegro’s growth is expected to remain 2025, when a large Eurobond is redeemed. strong at 4.8 percent in 2023, underpinned Maintaining commitment to important by private consumption and service exports, reforms will be crucial as Montenegro will need while investments remain subdued. However, to tap the market for funding over this period. the slowing of the global economy is weighing down on Montenegro’s outlook. Over 2024– The outlook is characterized by downside 25, declining private consumption growth is risks. High geopolitical uncertainties may expected to result in a slower average growth of weaken growth prospects in Montenegro’s 3.2 percent. Tourism is likely to surpass its 2019 major trading partners. Monetary tightening is level in 2023, and continue growing, although rapidly increasing the cost of external financing. deteriorating growth prospects in the EU and These conditions may lead to greater difficulty the region may adversely affect tourism. Due in mobilizing large amounts of capital at to an expected stabilization of exports growth favorable terms, particularly if fiscal targets are and moderation of imports, due to slowing not solidified through fiscal prudence. Political domestic consumption, the CAD is expected challenges are major domestic risks. The severity to moderate to 10.9 percent of GDP by 2025. of challenges ahead, however, requires strong political and economic stewardship through In the medium term, the fiscal deficit is carefully designed and well-costed policies. expected to remain elevated. While one-off revenues will result in the lower-than-planned Montenegro 85 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 GDP growth is forecasted at strong ...supported by continuous tourism 4.8 percent… recovery. Real GDP growth, percent International tourist overnight stays, in million 16 5 12 4 8 4 3 0 -4 2 -8 1 -12 -16 0 e 15 16 17 18 19 20 21 22 23 n b ar r ay n l g p t v c Ju Oc Ap No De Au 20 20 20 Fe Se Ja Ju 20 20 20 20 20 20 M M J 2019 J 2022 J 2023 Sources: MONSTAT data; World Bank staff calculations. Sources: MONSTAT; World Bank staff calculations. Employment gains have been strong... …while inflation has eased. Administrative data, in thousands, Jan 2018–Jul 2023 Jan 2018–Jul 2023, percent EUR 2015 300 70 20 700 250 60 600 15 50 500 200 10 400 40 150 30 5 300 100 200 20 0 50 10 100 0 0 -5 0 18 8 19 9 20 0 21 Ja 1 22 Ja 2 23 3 18 8 19 9 20 0 21 Ja 1 22 Ja 2 23 3 l-2 l-2 l-2 l-2 l-2 l-2 l-1 l-1 l-1 l-1 l-2 l-2 n- n- n- n- n- n- n- n- n- n- n- n- Ju Ju Ju Ju Ju Ju Ju Ju Ju Ju Ju Ju Ja Ja Ja Ja Ja Ja Ja Ja ▬ Employment (lhs) ▬ Unemployment (rhs) ▬ CPI (lhs) ▬ Real net wage (rhs) Source: MONSTAT data. Sources: MONSTAT data; World Bank staff calculations. Note: tc = trend cycle. Outstanding loans increased strongly. The fiscal deficit narrowed. Jan 2018–Jul 2023, in million EUR 2018–23, percent of GDP 4.5 60 0 4.0 50 -2 3.5 3.0 40 -4 2.5 2.0 30 -6 1.5 20 -8 1.0 0.5 10 -10 0 18 8 19 9 20 0 21 1 22 2 23 3 -12 l-2 0 l-2 l-2 l-1 l-1 l-2 n- n- n- n- n- n- Ju Ju Ju Ju Ju 2018 2019 2020 2021 2022 2023e Ju Ja Ja Ja Ja Ja Ja J Private corporate J Government J Households J Total revenues and grants J Total expenditure and net lending J Financial sector J Other ▬ Fiscal balance (rhs) Sources: Central Bank; World Bank staff calculations. Sources: Ministry of Finance; World Bank staff calculations. 86 Montenegro TOWARD SUSTAINABLE GROWTH MONTENEGRO Selected Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) -15.3 13.0 6.4 4.8 3.2 3.1 Composition (percentage points): Consumption -3.9 4.1 9.0 6.3 3.2 3.4 Investment -5.9 -4.7 4.9 -2.2 0.8 0.9 Net exports -5.5 13.7 -7.4 0.5 -0.9 -1.2 Exports -24.2 25.7 11.5 6.4 3.0 2.7 Imports (-) -18.7 12.0 18.9 5.9 3.9 3.9 Consumer price inflation (percent, period average) -0.3 2.4 13.0 8.4 4.0 2.8 Public revenues (percent of GDP) 44.4 44.0 38.6 40.5 39.0 39.1 Public expenditures (percent of GDP) 55.5 45.9 43.6 42.5 42.9 42.7 Of which: Wage bill (percent of GDP) 13.5 12.2 10.5 10.4 10.2 10.0 Social benefits (percent of GDP) 13.4 11.5 11.3 11.8 11.9 11.8 Capital expenditures (percent of GDP) 7.5 5.7 6.0 4.6 5.4 5.4 Fiscal balance (percent of GDP) -11.0 -1.9 -5.1 -2.0 -3.9 -3.6 Primary fiscal balance (percent of GDP) -8.3 0.5 -3.4 -0.3 -1.8 -1.0 Public debt (percent of GDP) 105.3 84.0 69.3 62.1 66.1 62.3 Public and publicly guaranteed debt (percent of GDP) 106.8 86.8 71.7 64.2 68.1 64.2 Of which: External (percent of GDP) 91.6 78.3 62.6 57.0 62.0 57.2 Goods exports (percent of GDP) 9.8 10.6 12.9 12.0 12.2 12.4 Goods imports (percent of GDP) 49.0 49.3 58.0 56.8 55.9 55.0 Net services exports (percent of GDP) 4.2 19.3 22.2 25.6 25.5 24.8 Trade and services balance (percent of GDP) -35.0 -19.4 -22.8 -19.2 -18.2 -17.8 Net remittance inflows (percent of GDP) 5.3 6.1 6.5 6.4 6.2 6.1 Current account balance (percent of GDP) -26.1 -9.2 -12.9 -11.5 -11.3 -10.9 Net foreign direct investment inflows (percent of GDP) 11.2 11.7 13.2 8.0 8.1 7.9 External debt (percent of GDP) 221.6 190.0 158.6 144.0 137.5 132.6 Real private credit growth (percent, period average) 6.4 -0.2 -4.9 – – – Nonperforming loans (percent of gross loans, end of period) 5.9 6.8 6.3 – – – Unemployment rate (percent, period average) 17.9 16.6 14.7 – – – Youth unemployment rate (percent, period average) 36.0 37.1 29.4 – – – Labor force participation rate (percent, period average) 53.3 50.9 58.9 – – – GDP per capita, PPP (current international $) 20,511 23,440 26,984 30,918 33,076 35,050 Poverty rate (percent of population) 21.1 18.3 17.2 16.4 15.7 15.2 Sources: Country authorities; World Bank estimates and projections. Note: e = estimate; f = forecast; PPP = purchasing power parity; – = not available. Poverty rate calculations based on ECAPOV harmonization using SILC-C data. Nowcasted/projected values start at 2019. Income measures in the SILC and consumption measures in the HBS are not strictly comparable. Poverty is defined as living on less than $6.85/day per person in revised 2017 PPPs. Montenegro 87 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 North Macedonia • While the economy showed some resilience to crises, consumption is decelerating driven by the increased cost of living, while manufacturing struggles as external demand slows. • Public finances are overstretched amidst a rise in borrowing costs. Fiscal consolidation needs to be prioritized to help accommodate new spending commitments on wages and public investments. • Headline inflation is decelerating but is projected to remain high in 2023 and fall towards the long-term average by 2025. Yet, wage pressures may lead to protracted inflationary pressures. • The medium-term outlook is positive, but downside risks prevail. Boosting growth and accelerating income convergence calls for much-needed reforms that are on halt due to a lasting parliamentary impasse. Recent Economic Developments issued by June can slow construction activity over the coming months, while real retail trade Economic growth started decelerating in declined by 3.9 percent in July 2023. Tourism the second quarter of 2023. After growing observed steady improvement over the summer by 2.1 percent in Q1 2023, output increased season. by only 1.1 percent on an annual basis in Q2 2023, led by private consumption while exports External sector imbalances eased. The current and gross capital investments fell as external account deficit declined to 1.1 percent of GDP demand slowed and stocks declined. Further, by Q2 202311, largely due to an improvement consumption eased to 1.6 percent (down by in the merchandise trade balance. With energy 1.1 pp from the quarter before) as continued import pressures abating, the trade deficit high inflation and credit slowdown put a dent shrunk by more than 6 percentage points (pp) on household purchasing power. Overall, to 20.5 percent of GDP. At the same time, H1 growth turned at 1.6 percent compared the services surplus softened to 4.8 percent of to 3.1 in H1 2022. On the production side, GDP owing to outlays for public infrastructure output growth in H1 2023 was driven by works. The primary income deficit remained services and industry, while construction and broadly unchanged despite a rise in interest agriculture sectors continued to struggle. After payments, while the secondary account surplus a sharp increase in Q1, the construction output stood high supported by solid remittances. FDI dropped by close to 22 percent in Q2. inflows decelerated to 4.7 percent of GDP but financed the CAD and increased gross foreign High-frequency data point to a slowdown of exchange reserves. Gross external debt declined growth in the third quarter of 2023. Industrial to an estimated 76.9 percent of GDP by March production declined by 1.8 percent10 in July as 2023. mining and manufacturing lost ground while energy production intensified. A reduction in the number and value of building permits 10 On annual basis. 11 On a four-quarter rolling basis. 88 North Macedonia TOWARD SUSTAINABLE GROWTH Despite sizeable government support, and the government support measures to structural labor market challenges persist. control the prices of basic food products helped In Q2 2023,12 the participation rate slightly to contain the rise in prices responsible for half increased to 52.4 percent compared to a quarter of the inflation increase in the first half of 2023. earlier. However, the female participation rate, As food prices and energy prices eased, the at 42.5 percent, remains 20 pp lower than that inflation rate slowed to 8.3 percent in August for men. Care for children and the elderly is 2023. However, second-round and spillover cited as one of the primary reasons for inactivity effects have kept core inflation high at around of women but firms in North Macedonia are 8 percent. Inflation expectations measured in least prepared in the region to offer child-care Q2 2023 stand at 9.3 percent for 2023, despite benefits or flexible working arrangements.13 a mild improvement relative to the previous The employment rate increased by 0.4 pp to survey round from Q1 2023. 45.5 percent, while the unemployment rate declined to 13.1 percent, on account of more Monetary policy tightening continued as jobs for the younger cohort and the exit to inflationary pressures persist. By August inactivity of the older cohorts. The youth 2023, the central bank had raised the key unemployment rate declined to 25.6 percent, policy rate to 6.15 percent up from a historical still significantly higher than the EU average. low of 1.25 percent before the beginning of the tightening cycle in spring 2022. The NBRM Sustained wage growth has outpaced also aimed to bolster the denarization process inflation since April 2023. Wage growth in banks’ balance sheets through raising the was registered in all economic sectors in the rate of mandatory reserves for foreign exchange first half of the year, led by a mandatory rise liabilities from 19 to 20 percent. The pegged of the minimum wage. For construction, exchange rate has remained stable and FX administrative and education workers wage reserves have recovered from losses incurred growth was above average. Wages are set to largely at the outbreak of the war in Ukraine, rise even further as the Government signed a standing at more than 4 months of imports in new collective agreement for the public sector June 2023. The stability of the banking sector that includes: a 10 percent wage increase as of was preserved with an increase in the capital September 2023; a revision to the wage-setting adequacy ratio to 18 percent in Q1 2023 despite methodology in 2024 linking the base wage to a drop in the liquidity rate to 19.1 percent that the national gross wage; an annual leave bonus remains adequate. At the same time, the non- at 30 percent of the average net wage; and performing loans ratio declined to 2.8 percent. loyalty bonuses. Credit growth slowed to 5.8 percent in July 2023 largely due to reduced borrowing by Headline inflation decelerated to single firms as financial conditions worsened. digits in June 2023 after reaching 19.8 percent in October 2022. Global pressures abating, monetary policy tightening, 12 The Q1-Q2 2023 data are not fully comparable to previous labor data due to methodological changes and the revision of the sample based on the 2021 census. All figures are on a quarter by quarter comparison. 13 Eurostat, Balkan Barometer Business Survey 2023. North Macedonia 89 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Fiscal pressures continued. The public Outlook and Risks deficit in 2023 is likely to remain as high as in 2022. The general government deficit (with The medium-term outlook is positive, but the Public Enterprise for State Roads finances downside risks prevail. Growth in 2023 is included) is projected at 4.8 percent of GDP expected to increase modestly by 1.8 percent, in 2023 after the budget technical reallocation reflecting a slowdown in the country’s main that is needed to accommodate new wage trading partners as second-round effects spending commitments. The fiscal implications from the war in Ukraine took force. Growth of the public sector collective agreement are is expected to moderately accelerate in estimated in the order of 0.7–0.8 percent the medium term led by the rise in public of GDP on average per year and add to the investments and recovered consumption earlier minimum wage adjustment and an before slowing towards the potential growth upward correction of public officials’ wages. trend thereafter. Public debt is expected to By June 2023, the general government deficit increase over the medium term owing to the reached an estimated 2.6 percent of GDP as Corridor VIII and Xd highway sections and VAT revenues declined while investment and wage spending commitments. Fiscal deficit is social spending went up. At the same time, the projected to drop below 3 percent of GDP only collection of profit tax revenues increased as from 2027. some of the TIDZ firms graduated from the tax exemption scheme. The recent adoption of the As commodity prices ease, the inflation rate solidarity tax as well as CIT and VAT reforms is projected to decelerate to the long-term will slightly ease the pressure for Q4 2023. average by 2025. Assuming that the impact of crises subsides over the forecast horizon, Public and publicly guaranteed and non- inflation is estimated to decline to 9.1 percent guaranteed debt stood well above the pre- in 2023 and to fall to the long-term average of crisis level. At 59.1 percent of GDP in June 2 percent by 2025. Tightening monetary policy 2023, public debt is 10 pp above the level in is expected to continue over the near term but 2019. Inflation helped reduce somewhat the to gradually ease as underlying price pressures debt-to-GDP ratio, but nominal public debt subside. continues to rise. Expenditure arrears remain consistently above 3 percent of GDP, largely While underlying risks remain largely skewed due to state-owned enterprise, health sector, to the downside and reflect the outlook for and local government nonpayment. As part the country’s main trading partners, moving of the PLL arrangement with the IMF, the ahead with EU accession negotiations may Government has committed to reduce payment accelerate critical reforms and unlock growth. arrears to the private sector. However, heightened political uncertainty and a prolonged parliamentary impasse due to lack of consensus for constitutional changes and upcoming parliamentary and presidential elections in the first half of 2024 may delay reform implementation. Finally, policy slippages may weaken fiscal sustainability 90 North Macedonia TOWARD SUSTAINABLE GROWTH and strengthen inflation persistence in turn requiring additional monetary tightening that can further restrict financing options and decelerate economic activity going forward. Overlapping crises have scarred the growth potential and further slowed convergence with the EU. Moving from middle- to high- income status requires following up on pending reforms and addressing critical impediments for future growth. Policy actions need to be geared to rebuild buffers and reduce vulnerabilities to future shocks. Boosting productivity, advancing on inclusion, and enhancing fiscal and environmental sustainability are critical for long-term steady growth in the context of pronounced and widespread uncertainty. Decarbonizing the economy and building resilience to climate change shocks is needed to maintain international competitiveness ahead of the EU Cross-Border Adjustment Mechanism implementation. Increasing productive capital expenditures as a share of the medium-term budget while maintaining fiscal sustainability would be crucial for boosting growth. North Macedonia 91 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Growth started decelerating… ...and high-frequency indicators point to a slowdown ahead. Percent change, contributions to growth Trend cycle (tc) adjusted, 2011=100 15 440 260 390 240 10 340 220 290 200 5 240 180 0 190 160 140 140 -5 90 120 40 100 -10 18 8 19 Ja 9 20 0 21 Ja 1 22 Ja 2 23 3 l-2 l-2 l-2 l-1 l-1 l-2 2023 2023 n- n- n- n- n- n- 2018 2019 2020 2021 2022 Ju Ju Ju Ju Ju Ju Ja Ja Ja Q1 Q2 J Consumption J Investment J Net exports ▬ GDP ▬ Industry_tc ▬ Retail trade_tc ▬ Tourism_tc ▬ Construction_tc (rhs) Sources: State Statistics Office; World Bank staff calculations. Sources: State Statistics Office; World Bank staff calculations. Participation rates declined in 2023. Inflation hit a single digit bound over the summer... Percent Percent, yearly change 80 25 70 20 60 15 50 40 10 30 5 20 0 10 0 -5 18 8 19 9 20 0 21 1 22 2 23 3 8 8 9 9 0 0 1 1 2 2 3 l-2 l-2 l-2 l-1 l-1 l-2 -2 -2 -2 -2 n- -2 n- -1 -1 n- -1 -1 -2 -2 n- n- n- Ju Ju Ju Ju Ju Q1 Q3 Q1 Q3 Q1 Q3 Ju Q1 Q3 Q1 Q1 Q3 Ja Ja Ja Ja Ja Ja J Activity rate (women) Q Activity rate (men) ▬ CPI total ▬ PPI Source: State Statistics Office. Source: State Statistics Office. Note: LFS 2021 and 2022 make use of the 2021 census data, Q1 2023 contains a methodological change, thus making a break in the series. ...and external imbalances eased as The public debt decreased with the help imports slowed. of inflation amidst a rise in expenditure arrears. Percent of GDP Percent of GDP 30 1 70 1 25 0 20 0 60 -1 15 -1 50 -2 10 5 -2 -3 40 0 -4 -3 -5 30 -5 -10 -4 -15 20 -6 -20 -5 -7 -25 10 -6 -8 -30 0 -9 -35 -7 2023 2023 2018 2019 2020 2021 2022 2023* 2018 2019 2020 2021 2022 Q1 Q2 J Goods J Services J Income J Current transfers J Domestic debt J Foreign debt J Guarantees ▬ Fiscal deficit (rhs) ▬ Current account balance (rhs) Source: Central bank. Sources: Ministry of Finance; World Bank estimates. Note: 2023 is a rolling average until June 2023. Note: Fiscal deficit includes Public Enterprise for State Roads 92 North Macedonia TOWARD SUSTAINABLE GROWTH NORTH MACEDONIA Selected Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) -4.7 3.9 2.1 1.8 2.5 2.9 Composition (percentage points): Consumption -1.5 6.4 2.9 1.2 1.2 1.9 Investment -5.7 0.3 4.9 2.1 1.8 1.9 Net exports 2.5 -2.7 -5.7 -1.5 -0.6 -0.9 Exports -7.4 7.4 9.2 4.6 4.3 4.1 Imports (-) -9.9 10.2 14.8 6.1 4.9 5.0 Consumer price inflation (percent, period average) 1.2 3.2 14.2 9.1 3.0 2.0 Public revenues (percent of GDP) 29.9 32.5 32.4 34.9 35.0 35.7 Public expenditures (percent of GDP) 38.1 37.9 36.9 39.4 39.2 39.2 Of which: Wage bill (percent of GDP) 7.2 6.9 6.5 6.6 6.9 7.1 Social benefits (percent of GDP) 17.6 16.9 16.6 16.7 16.6 16.5 Capital expenditures (percent of GDP) 3.1 4.2 4.2 6.7 6.3 6.6 Overall fiscal balance (percent of GDP) -8.2 -5.4 -4.5 -4.5 -4.1 -3.5 Overall fiscal balance with the Public Enterprise for State Roads -8.6 -5.8 -4.8 -4.8 -4.5 -3.8 included (percent of GDP) Primary fiscal balance (percent of GDP) -7.0 -4.1 -3.3 -3.2 -2.4 -1.5 Public debt (percent of GDP) 50.8 52.0 50.9 51.7 53.3 54.5 Public and publicly guaranteed debt (percent of GDP)* 59.8 61.0 59.6 60.2 61.5 62.2 Of which: External (percent of GDP) 39.9 39.9 39.1 38.7 38.8 38.3 Goods exports (percent of GDP) 44.4 51.3 57.0 56.8 57.5 58.5 Goods imports (percent of GDP) 61.0 71.6 83.7 82.3 82.5 83.1 Net services exports (percent of GDP) 3.9 4.2 5.7 6.9 7.3 7.6 Goods and services trade balance (percent of GDP) -12.7 -16.0 -21.0 -18.6 -17.7 -17.0 Remittance inflows (percent of GDP) 3.1 2.9 2.7 2.9 2.8 2.7 Current account balance (percent of GDP) -2.9 -3.1 -6.0 -3.7 -3.2 -2.8 Net foreign direct investment inflows (percent of GDP) 1.4 3.3 5.2 5.2 4.7 4.2 External debt (percent of GDP) 78.7 81.9 84.2 80.0 82.7 82.8 Real private credit growth (percent, period average) 5.6 2.8 -4.2 – – – Nonperforming loans (percent of gross loans, end of period) 3.3 3.1 2.8 – – – Unemployment rate (percent, average)** 16.4 15.4 14.4 – – – Youth unemployment rate (percent, period average) 35.7 36.3 32.5 – – – Labor force participation rate (percent, period average) 56.4 56.0 55.2 – – – GDP per capita, PPP (current international $)** 13,562 14,096 14,398 14,657 15,024 15,459 Poverty rate (percent of population) 20.1 19.1 18.3 17.9 17.3 16.2 Sources: Country authorities; World Bank staff estimates and projections. Note: *Includes non-guaranteed debt of SOEs, as well. **Data from 2021 and 2022 are not fully comparable to previous labor data due to the change in the LFS sample based on the 2021 census. Data for 2023 is the latest available. Youth unemployment rate is for labor force aged 15–24. e = estimate; f = forecast; PPP = purchasing power parity; – = not available. Poverty rate calculations based on ECAPOV harmonization using SILC-C data. Nowcasted/projected values start at 2020. Income measures in the SILC and consumption measures in the HBS are not strictly comparable. Poverty is defined as living on less than $6.85/day per person in revised 2017 PPPs. North Macedonia 93 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Serbia • Even though some acceleration of the economic activity is expected in H2, results from the first half of the year suggest that annual GDP growth in 2023 will be around 2 percent. • Inflation has started to decline, but it is still among the highest in Europe. It is expected that it will return to the NBS target band in mid-2024. • Fiscal performance has been better than expected, with a lower-than-anticipated deficit, thanks to a strong performance of revenues, while public debt has plateaued at around 56 percent of GDP. • The CAD will be lower than expected in 2023, at about 2.5 percent of GDP, and the strong inflow of FDI continues. As a result, foreign currency reserves have increased to a record high. • While growth projections over the medium term (2024–2026) remain unchanged, those are still below potential growth rates. This underlines the importance of structural reforms to accelerate growth in potential output. • A possible new source of growth could be FDI in high value-added sectors, but there are risks too, in particular those related to SOEs, both in terms of the impact of SOEs on fiscal balances and on market competition. Recent Economic Developments investment decreased by 15.2 percent (yoy) in real terms, primarily as a result of a major The Serbian economy grew slower than decrease in inventories. On the production expected in H1 2022. The start of the year was side, some agriculture products were hit by particularly weak with growth in Q1 estimated unfavorable weather conditions (fruits and at 0.9 percent only. In Q2, the situation vegetables in particular), but the wheat and improved somewhat as the construction corn harvest was better than expected, thus sector started to recover, contributing to helping the agriculture sector as whole to grow GDP growth that reached 1.7 percent, yoy. by 9.9 percent in H1 2023. The construction In the first half of the year, economic growth sector started to recover with strong growth was supported heavily by net exports. While of 17.9 percent, yoy, in Q2 2023, after four exports of goods saw an encouraging expansion consecutive quarters of decline. Industrial (up by 9.4 percent in euro terms in H1), there production increased by 1.7 percent (yoy) in was a noticeable decrease in imports (down H1, driven by an improvement in the energy 5 percent in H1), in particular imports of sector (up by 6.4 percent), while manufacturing energy (down 24.5 percent) and raw materials declined by 1 percent in H1. Value added in (down 6.4 percent) which led to a significant services sectors increased by just 0.7 percent (in positive contribution to growth in H1. Both real terms, yoy) in the first half of the year. consumption and investment had a negative contribution to growth in H1. Consumption The labor market was, by and large, is being hit by the effects of prolonged high resilient to the shock caused by the inflation, while investment was impacted by a pandemic, and the unemployment rate has major decrease in inventories (while gross fixed remained stable at around 10 percent. In capital formation had a positive contribution Q2 2023, the unemployment rate decreased to growth). In the first half of the year, total to 9.6 percent, compared to 10.1 percent 94 Serbia TOWARD SUSTAINABLE GROWTH in Q1 (or 9.4 percent on average in 2022). 2023, compared to the same period of 2022. Labor market improvements also resulted As a result of a major decrease of the CAD in in a higher employment rate, which reached H1, it is now projected to decrease to around 50.4 percent in Q2 2023. Nevertheless, 2.5 percent of GDP for 2023 as a whole. the youth unemployment rate remained Financing flows remain comfortable as net structurally high at around 25 percent. Wages foreign direct investment inflows increased by continued to rise, increasing by 15.4 percent in almost 35 percent compared to the same period nominal terms in H1 2023. of 2022, to reach EUR 2 billion in the first half of 2023. Most importantly, inflows related to The consolidated budget shifted to a small equity and investment fund shares increased surplus of 0.6 percent of annual GDP over by over 50 percent. As a result, there was a the first six months of 2023. Revenues posted significant increase in official foreign currency a strong performance (up 12.5 percent in reserves which stood at EUR 22.6 billion at the nominal terms, in H1, yoy), thanks to major end of June, covering 6 months of imports. increases in corporate income tax (CIT), social contributions and domestic VAT. High Inflation remains stubbornly high, and inflation, among others, drove VAT revenues, has only started to fall later than in peer while improved CIT collection reflects the CEE countries. The consumer price index recovered profitability of businesses in 2022. (CPI) peaked at 16.2 percent (yoy) in March, Social contributions increased on the back the highest level of inflation since the CPI of both higher formal employment (up measurement begun (in January 2007). Inflation 2.7 percent in H1, yoy) and nominal wages has started to fall since then, and reached (up 15.4 percent in H1, yoy). Meanwhile, 11.5 percent in August. Notwithstanding the expenditures have been kept under control (up fact that inflation started and reached its peak by 7.7 percent over the same period). According at different times across countries, inflation in to the supplementary budget (in preparation) Serbia is still among the highest in Europe.14 this year’s fiscal deficit should be 2.8 percent Food prices, notwithstanding the selective of GDP, which could go even further down government price controls, drove this trend, to 2.5 percent of GDP. Public debt remained increasing by 21.1 percent (yoy) in July 2023. broadly stable throughout 2023 and stood at It is expected that inflation will return to the around 56 percent of GDP. NBS target band in mid-2024. Importantly, producer prices as measured by PPI went down As last year’s extraordinary imports of energy significantly over recent months and in July stopped, there is a significant improvement were only 0.5 percent higher than a year earlier. in the BOP in the first half of the year. The The NBS decided to keep the key interest rate CAD decreased by 82 percent in H1 (from unchanged in both August and September at EUR 2.9 billion in H1 2022 to EUR 0.5 billion 6.5 percent after 16 months of continuous, in H1 2023). The trade balance shrank by gradual increases. The nominal exchange rate 40 percent as imports of energy (both gas remains stable but there has been a significant and electricity) decreased by 24.5 percent (or appreciation of the REER over the first seven EUR 926 million) over the first six months of months of 2023 (by 4.4 percent). 14 Only Hungary has a higher inflation according to Eurostat July data. Serbia 95 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 The performance of the banking sector has Growth constraints could be removed continued to be robust. Based on 2023 Q2 by a more ambitious domestic reform data, banks remained profitable and liquid. The agenda and its implementation. The recent liquidity ratio increased from 2.2 at the end of crisis in the domestic energy sector has once 2022 to 2.4 in June, while the capital adequacy again emphasized the urgency of improving ratio increased to 22.3 percent at the end of June the management of SOEs. Therefore, the (compared to 20.2 at the end of 2022). Non- government should embark on an even performing loans (NPLs) stood at 3.2 percent more decisive, comprehensive and thorough in June, a slight increase compared to 3 percent reform of SOEs to make them financially and at the end of 2022. Credit growth has slowed operationally viable. There are other reforms down in 2023 due to tightening monetary related to governance, education, transport, conditions. The total stock of loans in June municipal-level utility services, financial sector was only 2 percent higher than a year earlier. etc. that should help Serbia to grow much The highest increase in credit growth relates to faster. loans to government (up by 6.7 percent, yoy) while loans to private companies increased by The risks to the baseline macroeconomic a mere 0.3 percent (yoy) and to households by outlook that could materialize in 2023 and 2.6 percent (yoy, as of June). beyond are numerous. First, high inflation could persist for an unexpectedly long period and a more coordinated effort between fiscal Outlook and Risks and monetary policy would be needed to help to bring it down to the targeted level. High The growth outlook remains positive with inflation hurts growth and diminishes gains in risks tilted to the downside. The Serbian improved living standards, especially for the economy started to slow down in the second poor. Second, it is critical, given Serbia’s levels half of 2022, a trend that continued in the of public debt, that scarce public investment first half of 2023. However, in mid-2023 the resources are prioritized towards projects with construction sector started to recover, and high economic and social returns, and are some agriculture sectors (wheat and corn balanced against fiscal risks over the medium production in particular) scored better than to long run. expected results. Considering the impact of these factors, it is expected that growth will accelerate in the second half of 2023 thus leading to a growth rate of 2 percent for the year as whole. Going forward and over the medium term, it is expected that growth will be around 3–4 percent. These are rates that are below Serbia’s potential and any acceleration in growth will be dependent on structural reforms. 96 Serbia TOWARD SUSTAINABLE GROWTH Growth started to recover as of Q2… ...with all three broad sectors contributing to growth. Contribution to growth, percentage points Contribution to growth of value added, yoy 21 14 18 12 15 10 12 8 9 6 6 4 3 2 0 0 -3 -2 -6 -4 -9 -6 -12 -8 Q2 19 Q3 19 Q4 19 Q1 19 Q2 20 Q3 20 Q4 20 Q1 20 Q2 21 Q3 21 Q4 21 Q1 21 Q2 22 Q3 22 Q4 2 Q1 22 Q2 23 3 Q2 0 Q3 0 Q4 0 Q1 0 Q2 1 Q3 1 Q4 1 Q1 1 Q2 2 Q3 2 Q4 2 Q1 2 Q2 3 3 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 -2 - - - - - - - - - - - - - - - - Q1 Q1 J Consumption, final J Investment J Industry total J Services total J Agriculture J Net exports ▬ Real GDP growth, percent ▬ Total value added Source: Statistics Office of the Republic of Serbia. Source: Statistics Office of the Republic of Serbia. Inflation is currently higher than in peer …leading to a strong REER appreciation. countries… Annual change in percent 2005=100 30 145 25 140 20 135 15 10 130 5 125 0 -5 120 Fe -22 a 2 Apr-22 ay 2 Ju -22 Ju -22 Au l-22 Se g-22 Oc -22 2 Dev-22 Ja 22 Fe -23 a 3 Apr-23 ay 3 Ju -23 Ju -23 3 Ap 20 Ju 0 Oc 20 Ja 0 Ap 21 Ju 1 Oc 21 Ja 21 Ap 22 Ju 2 Oc 2 Ja 22 Ap 23 Ju 3 3 M -2 M r-2 No t-2 M -2 M r-2 l-2 2 2 l-2 2 l-2 c- 2 2 n- r- l- t- n b n p n b n n- r- t- n- r- r- l- t- n- Ja Ja ▬ EU ▬ BGR ▬ CZE ▬ EST ▬ HRV ▬ LVA ▬ LTU ▬ HUN ▬ POL ▬ ROU ▬ SVN ▬ SVK ▬ MNE ▬ MKD ▬ ALB ▬ SRB ▬ KOS Sources: Statistics Office of the Republic of Serbia and Eurostat. Source: National Bank of Serbia. The CAD and trade deficit decreased… …and reserves recovered. Percent of GDP, 12-month sum Official foreign currency reserves, EUR million 0 24,000 -2 21,000 -4 18,000 -6 -8 15,000 -10 12,000 -12 9,000 -14 6,000 -16 -18 3,000 -20 0 22 M 2 2 2 22 22 23 M 3 3 3 18 8 19 9 20 0 21 1 22 2 23 3 -2 -2 l-2 -2 -2 l-2 l-2 l-2 l-2 l-1 l-1 l-2 n- p- v- n- n- n- n- n- n- ay ay ar ar n- Ju Ju No Se Ja Ja Ju Ju Ju Ju Ju Ju Ja Ja M M Ja Ja Ja Ja ▬ CAB (12m cumulative) ▬ Trade balance (12m cumulative) Source: National Bank of Serbia. Source: National Bank of Serbia. Serbia 97 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 SERBIA Selected Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) -0.9 7.5 2.3 2.0 3.0 3.8 Composition (percentage points): Consumption -0.8 6.0 2.5 0.2 1.7 2.8 Investment -0.2 2.6 1.9 -0.1 0.1 1.5 Net exports 0.1 -1.0 -2.2 1.9 1.2 -0.5 Exports -2.3 10.4 10.4 2.7 2.8 4.6 Imports (-) -2.4 11.4 12.6 0.8 1.6 5.0 Consumer price inflation (percent, period average) 1.6 4.0 11.9 12.4 5.3 3.5 Public revenues (percent of GDP) 41.0 43.3 43.4 42.9 42.5 42.0 Public expenditures (percent of GDP) 49.0 47.4 46.4 45.6 44.5 43.5 Of which: Wage bill (percent of GDP) 10.5 10.0 9.6 9.7 10.0 9.9 Social benefits (percent of GDP) 14.7 13.6 13.1 13.4 13.9 13.3 Capital expenditures (percent of GDP) 5.3 7.4 7.3 6.9 6.7 6.9 Fiscal balance (percent of GDP) -8.0 -4.1 -3.0 -2.8 -2.0 -1.6 Primary fiscal balance (percent of GDP) -6.0 -2.4 -1.5 -1.0 0.0 0.3 Public debt (percent of GDP) 53.9 54.5 52.6 52.3 50.5 49.6 Public and publicly guaranteed debt (percent of GDP) 57.8 57.1 55.6 55.4 53.7 51.7 Of which: External (percent of GDP) 33.4 37.0 36.0 36.0 34.3 33.2 Goods exports (percent of GDP) 34.3 39.4 44.6 43.1 43.6 44.0 Goods imports (percent of GDP) 45.5 50.7 60.1 52.8 53.3 53.6 Net services exports (percent of GDP) 2.4 2.6 3.8 3.4 2.8 2.5 Trade balance (percent of GDP) -8.8 -8.7 -11.7 -6.2 -6.8 -7.0 Net remittance inflows (percent of GDP) 4.5 4.7 6.1 5.5 5.1 4.9 Current account balance (percent of GDP) -4.1 -4.2 -6.9 -2.5 -3.4 -4.3 Net foreign direct investment inflows (percent of GDP) 6.3 6.9 7.1 6.1 5.6 5.4 External debt (percent of GDP) 65.8 68.4 67.9 64.3 61.1 59.7 Real private credit growth (percent, period average) 9.2 3.7 -2.7 – – – Nonperforming loans (percent of gross loans, end of period) 3.7 3.6 3.0 – – – Unemployment rate (percent, period average) 9.7 11.0 9.4 – – – Youth unemployment rate (percent, period average) 27.7 26.4 24.4 – – – Labor force participation rate (percent, period average) 52.2 54.7 55.5 – – – GDP per capita, PPP (current international $) 19,556 21,642 22,901 27,330 29,096 31,409 Poverty rate (percent of population) 10.1 9.1 8.5 8.0 7.5 6.9 Sources: Country authorities; World Bank estimates and projections. Note: e = estimate; f = forecast; PPP = purchasing power parity; – = not available. Poverty rate calculations based on ECAPOV harmonization using SILC-C data. Nowcasted/projected values start at 2021. Income measures in the SILC and consumption measures in the HBS are not strictly comparable. Poverty is defined as living on less than $6.85/day per person in revised 2017 PPPs. 98 Serbia Key Economic Indicators WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Key Economic Indicators 2020 2021 2022 2023e 2024f 2025f Real GDP growth (percent) Albania -3.3 8.9 4.8 3.6 3.2 3.2 Bosnia and Herzegovina -3.0 7.4 3.9 2.2 2.8 3.4 Kosovo -5.3 10.7 5.2 3.2 3.9 4.0 North Macedonia -4.7 3.9 2.1 1.8 2.5 2.9 Montenegro -15.3 13.0 6.4 4.8 3.2 3.1 Serbia -0.9 7.5 2.3 2.0 3.0 3.8 WB6 -3.0 7.8 3.3 2.5 3.0 3.5 Consumer price inflation (percent, period average) Albania 2.2 2.6 6.7 5.0 3.5 3.0 Bosnia and Herzegovina -1.1 2.0 14.0 5.8 2.5 0.9 Kosovo 0.2 3.4 11.6 4.8 3.0 2.5 North Macedonia 1.2 3.2 14.2 9.1 3.0 2.0 Montenegro -0.3 2.4 13.0 8.4 4.0 2.8 Serbia 1.6 4.0 11.9 12.4 5.3 3.5 WB6 1.0 3.2 11.8 9.1 4.1 2.7 Public expenditures (percent of GDP) Albania 32.6 32.1 30.5 30.6 29.9 29.6 Bosnia and Herzegovina 46.8 41.3 39.7 41.5 40.9 41.5 Kosovo 33.0 28.8 28.2 29.2 30.1 30.1 North Macedonia 38.1 37.9 36.9 39.4 39.2 39.2 Montenegro 55.5 45.9 43.6 42.5 42.9 42.7 Serbia 49.0 47.4 46.4 45.6 44.5 43.5 WB6 42.5 38.9 37.6 38.2 37.9 37.8 Public revenues (percent of GDP) Albania 25.9 27.5 26.8 28.1 27.5 27.7 Bosnia and Herzegovina 41.6 41.1 40.1 40.7 41.0 41.5 Kosovo 25.4 27.4 27.8 28.7 28.2 28.3 North Macedonia 29.9 32.5 32.4 34.9 35.0 35.7 Montenegro 44.4 44.0 38.6 40.5 39.0 39.1 Serbia 41.0 43.3 43.4 42.9 42.5 42.0 WB6 34.7 36.0 34.9 36.0 35.5 35.7 Fiscal balance (percent of GDP) Albania -6.7 -4.6 -3.7 -2.5 -2.3 -1.9 Bosnia and Herzegovina -5.2 -0.3 0.4 -0.8 0.0 0.0 Kosovo -7.6 -1.3 -0.4 -0.6 -1.9 -1.9 North Macedonia -8.2 -5.4 -4.5 -4.5 -4.1 -3.5 Montenegro -11.0 -1.9 -5.1 -2.0 -3.9 -3.6 Serbia -8.0 -4.1 -3.0 -2.8 -2.0 -1.6 WB6 -7.9 -2.9 -2.7 -2.2 -2.4 -2.0 Source: World Bank calculations and projections on data from national authorities and World Economic Outlook. 100 Key Economic Indicators TOWARD SUSTAINABLE GROWTH Key Economic Indicators (continued) 2020 2021 2022 2023e 2024f 2025f Public debt (percent of GDP) Albania 73.0 71.5 62.1 60.3 59.4 58.5 Bosnia and Herzegovina 36.1 34.0 29.3 27.6 27.0 26.3 Kosovo 22.0 21.2 19.6 18.5 19.3 19.8 North Macedonia 50.8 52.0 50.9 51.7 53.3 54.5 Montenegro 105.3 84.0 69.3 62.1 66.1 62.3 Serbia 53.9 54.5 52.6 52.3 50.5 49.6 WB6 56.9 52.9 47.3 45.4 45.9 45.2 Public and publicly guaranteed debt (percent of GDP) Albania 75.8 75.4 65.4 63.1 62.1 60.8 Bosnia and Herzegovina 38.8 37.6 31.5 29.5 29.2 28.5 Kosovo 22.4 21.6 19.9 18.6 19.5 20.1 North Macedonia 59.8 61.0 59.6 60.2 61.5 62.2 Montenegro 106.8 86.8 71.7 64.2 68.1 64.2 Serbia 57.8 57.1 55.6 55.4 53.7 51.7 WB6 60.2 56.6 50.6 48.5 49.0 47.9 Goods exports (percent of GDP) Albania 6.0 8.3 10.8 9.3 9.3 9.3 Bosnia and Herzegovina 27.1 32.5 35.4 36.9 36.4 35.8 Kosovo 7.0 9.5 10.4 8.8 9.0 9.2 North Macedonia 44.4 51.3 57.0 56.8 57.5 58.5 Montenegro 9.8 10.6 12.9 12.0 12.2 12.4 Serbia 34.3 39.4 44.6 43.1 43.6 44.0 WB6 21.4 25.3 28.5 27.8 28.0 28.2 Trade balance (percent of GDP) Albania -14.3 -13.5 -10.4 -9.7 -9.8 -9.7 Bosnia and Herzegovina -13.7 -11.8 -14.2 -13.9 -14.0 -14.3 Kosovo -32.2 -31.8 -32.6 -29.1 -28.3 -27.7 North Macedonia -12.7 -16.0 -21.0 -18.6 -17.7 -17.0 Montenegro -35.0 -19.4 -22.8 -19.2 -18.2 -17.8 Serbia -8.8 -8.7 -11.7 -6.2 -6.8 -7.0 WB6 -19.5 -16.9 -18.8 -16.1 -15.8 -15.6 Current account balance (percent of GDP) Albania -8.5 -7.8 -6.0 -5.6 -5.8 -5.6 Bosnia and Herzegovina -3.2 -2.4 -4.5 -4.7 -4.8 -5.1 Kosovo -7.0 -8.7 -10.5 -6.5 -6.0 -5.5 North Macedonia -2.9 -3.1 -6.0 -3.7 -3.2 -2.8 Montenegro -26.1 -9.2 -12.9 -11.5 -11.3 -10.9 Serbia -4.1 -4.2 -6.9 -2.5 -3.4 -4.3 WB6 -8.6 -5.9 -7.8 -5.8 -5.7 -5.7 Source: World Bank calculations and projections on data from national authorities and World Economic Outlook. Key Economic Indicators 101 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.24 Key Economic Indicators (continued) 2020 2021 2022 2023e 2024f 2025f External debt (percent of GDP) Albania 60.5 62.7 54.3 51.8 50.0 49.0 Bosnia and Herzegovina 69.7 62.4 60.5 60.0 59.1 57.4 Kosovo 36.9 37.6 38.2 38.4 39.0 39.9 North Macedonia 78.7 81.9 84.2 80.0 82.7 82.8 Montenegro 221.6 190.0 158.6 144.0 137.5 132.6 Serbia 65.8 68.4 67.9 64.3 61.1 59.7 WB6 88.9 83.9 77.3 73.1 71.6 70.2 Unemployment rate (period average, percent) Albania 11.7 11.5 11.0 - - - Bosnia and Herzegovina 15.9 17.4 15.4 - - - Kosovo 25.9 20.7 12.6 - - - North Macedonia 16.4 15.4 14.4 - - - Montenegro 17.9 16.6 14.7 - - - Serbia 9.7 11.0 9.4 - - - WB6 16.3 15.4 12.9 - - - Source: World Bank calculations and projections on data from national authorities and World Economic Outlook. 102 Key Economic Indicators Western Balkans Regular Economic Report No.24 | Fall 2023 View this report online: www.worldbank.org/eca/wbrer