WESTERN BALKANS REGULAR ECONOMIC REPORT No.21 | Spring 2022 Steering Through Crises Western Balkans Regular Economic Report No.21 Steering Through Crises Spring 2022   © 2022 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 April 12, 2022. STEERING THROUGH CRISES 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 Sanja Madzarevic-Sujster, Richard Record, and Tihomir Stucka (Task Team Leaders). This issue’s core team included World Bank staff working on the Western Balkan countries (with additional contributions to specific sections): Marc Schiffbauer, Natasha Rovo, Ehab Tawfik (Growth section), Sanja Madžarević-Šujster, Joana Madjoska (Labor section), Trang Van Nguyen, Ana Maria Oviedo, Leonardo Lucchetti, Carlos Gustavo Ospino Hernandez (Poverty section), Milan Lakićević, Besart Myderrizi (Fiscal section), Hilda Shijaku, Christoph Ungerer (Monetary section), Alper Oguz, Jane Hwang (Financial sector section), Sandra Hlivnjak, Tihomir Stučka (External section), Lazar Šestović, Collette Mari Wheeler, Dhruv Devesh Gandhi (Outlook section), Simon David Ellis, Claudio Protano, Katharina Gassner, Rhedon Begolli, Pavlina Zdraveva, Sanja Madžarević-Šujster, Tihomir Stučka, Trang Van Nguyen, Ana Maria Oviedo, Carlos Gustavo Ospino Hernandez (Spotlight). Research assistance was provided by Suzana Jukić. Diane Stamm provided assistance in editing, and Budy Wirasmo assistance in designing. 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 Paul Clare, Sanja Tanić, Lundrim Aliu, Anita Božinovska, Ana Gjokutaj, Jasmina Hadžić, Gordana Filipovic, and Mirjana Popović. The team is grateful to Linda Van Gelder (Regional Director for the Western Balkans); Lalita Moorty (Regional Director, Equitable Growth, Finance and Institutions); Jasmin Chakeri (Practice Manager, Macroeconomics, Trade, and Investment Global Practice); and the Western Balkans Country Management team for their guidance in preparation of this report. The team is also thankful for comments on earlier drafts of this report received from the Ministries of Finance and Central Banks in Western Balkans countries. This Western Balkans RER and previous issues may be found at: www.worldbank.org/eca/wbrer/. Acknowledgements  |  iii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Contents Acknowledgementsiii Abbreviationsviii Steering Through Crises 1 1. Overview 2 2. Western Balkan economies have rebounded fast in 2021 7 3. Labor market recovery faces headwinds  12 4. Poverty reduction has resumed, but further progress is uncertain  17 5. Continued need for fiscal support against limited space 23 6. Higher inflation presents policy challenges 28 7. Financial stability continued to be preserved amid looming economic risks  32 8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the Western Balkans 38 9. The post-pandemic rebound is cut short 43 10. Spotlight: Managing the Energy Crisis in the Western Balkans 50 Country Notes 66 Albania67 Bosnia and Herzegovina 72 Kosovo78 Montenegro84 North Macedonia 91 Serbia97 Key Economic Indicators 103 iv  | Contents STEERING THROUGH CRISES List of Figures Figure 2.1. The economic recovery was strong throughout the Western Balkan countries in 2021 7  eal GDP level in the Western Balkan region is predicted to recover in 2022 Figure 2.2. R to its pre-COVID trend 7 Figure 2.3. The recovery was driven by a strong rebound in consumption and tourism 8 Figure 2.4. Consumption’s contribution to growth in 2021 was well above recent historic averages8 Figure 2.5. The fiscal multiplier for total expenditure remains below one 10 Figure 2.6. The fiscal impact after one year has been larger than historically 10 Figure 2.7. Fiscal impulse, automatic stabilization, and output gap 11 Figure 3.1. Employment recovered from mid-2021... 12 Figure 3.2. …led by public sector, industry, and services. 12 Figure 3.3. The service sector is an important employer… 13 Figure 3.4. …in the Western Balkans focused on low-skill sectors. 13 Figure 3.5. The largest number of employees is in low-skill services 14 Figure 3.6. The employment rate reached a historical high in the Western Balkans… 15 Figure 3.7. …while inactivity dropped in four countries. 15 Figure 3.8. More women returned to labor market than men 15 Figure 3.9. The unemployment rate declined except in Bosnia and Herzegovina and Serbia 15 Figure 3.10. Minimum wages increased in four countries 16  e region’s poverty rate declined in 2021, but there are significant risks for Figure 4.1. Th further reduction 17  ood price inflation could significantly affect the purchasing power of poor Figure 4.2. F households19  oor households experienced higher inflation than average households in Figure 4.3. P recent months 21 Figure 5.1. Fiscal balances improved across the Western Balkan countries… 23 Figure 5.2. …supported by revenue growth and lower expenditures. 23 Figure 5.3. Spending on social benefits and wages declined 24 Figure 5.4. Capital expenditures increased significantly in Serbia and Albania 24  ublic and publicly guaranteed debt declined in most countries, although it Figure 5.5. P remains elevated… 25 Figure 5.6. …and so did external debt. 25 Figure 6.1. Inflation picked up in 2021 in most EMDEs 29 Figure 6.2. Energy prices soared at the start of the war in Ukraine 29 Figure 6.3. Headline inflation in the WB6 started picking up in the second half of 2021 29 Figure 6.4. Energy and food inflation drove this increase 29 Figure 6.5. Core inflation has increased in most countries in the region 30 Figure 6.6. Inflationary expectations have started to materialize 30 Figure 7.1. Credit growth has been positive in all countries and is accelerating 33 Figure 7.2. Lending to households continued to drive credit growth 33 Contents  |  v WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 NPLs are consistently decreasing in Albania and Bosnia and Herzegovina Figure 7.3.  while increasing in Montenegro 35 Figure 7.4. Banks capital buffers preserved 35 Figure 8.1. Current account deficits (CAD) narrowed in most countries in the region… 39 Figure 8.2. …and were mostly met by recovering FDI. 39 Figure 9.1. Growth projections were revised downward 43 Food prices reached an all-time high, as did metals and minerals, while oil Figure 9.2.  prices increased sharply, too 43 Figure 9.3. Vaccination rates have stagnated well below EU rates 44 Figure 9.4. Global economic developments 47 Figure 10.1. Assessment of the vulnerability of WB6 countries to energy price shocks 53 Figure 10.2. Inability to keep the home adequately warm 54 Figure 10.3. Share of household consumption expenditure on electricity, gas, and other fuels is high, but even higher among the poor in some countries 54 Figure 10.4. Key macroeconomic indicators for WB6 countries 61 List of Tables Table 1.1. Western Balkans Outlook, 2019–2024 5 Poverty reduction at the country level is projected to slow in 2022, reflecting Table 4.1.  rising food and energy prices and impacts of the war in Ukraine 18 Table 5.1. Country credit ratings stayed mostly stable 26 Table 5.2. Estimated government support for the energy and food crisis, percent of GDP 26 Table 8.1. Heatmap of select transmission channels to Western Balkan countries 41 Table 10.1. Assessment of the impacts of electricity price increases in WB6 countries on sector stakeholders 56 Table 10.2. Assessment of the impacts of direct natural gas price increases in WB6 countries on sector stakeholders 58 vi  | Contents STEERING THROUGH CRISES List of Boxes Box 2.1. How much did the fiscal expansion contribute to the economic recovery? 9 Box 3.1. Services to the rescue: A labor market perspective  13 Box 4.1. The poor disproportionately feel the effects of inflation  20 Box 7.1. Greening the financial sector in the Western Balkans 36 Global economic recovery faces severe headwinds from war in Ukraine and Box 9.1.  COVID-19 pandemic 46 Contents  |  vii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Abbreviations AQR Asset Quality Review pp percentage points CAD current account deficit PPG public and publicly guaranteed CESEE Central, Eastern and South-Eastern PPP purchasing power parity Europe Q quarter CPI consumer price index S&P Standard & Poor’s ECA Europe and Central Asia 7STEEs seven small transition economies EMDEs emerging markets and developing of Europe, which are Bulgaria, economies Croatia, Estonia, Latvia, Lithuania, EPS Elektroprivreda Srbije (Serbia) the Slovak Republic, and Slovenia EU European Union SILC Survey of Income and Living EUR euro Conditions FBiH Federation of Bosnia and SOEs state-owned enterprises Herzegovina SWIFT Society for Worldwide Interbank FDI foreign direct investment Financial Telecommunication GDP gross domestic product TPP thermal power plant H1 first half (of the year) VAT value-added tax HBS Household Budget Survey WB World Bank ICT information and communications technology Country abbreviations kWh kilowatt hour ALB Albania LFS Labor Force Survey BIH Bosnia and Herzegovina LMIC low- and middle-income countries KOS Kosovo MWh megawatt hour MKD North Macedonia NBS National Bank of Serbia MNE Montenegro NPLs nonperforming loans SRB Serbia PM particulate matter WB6 Western Balkans 6 viii  | Abbreviations Steering Through Crises WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 1. Overview Just as the economies of the Western Balkans and travel restrictions. Investment also saw a were looking to growth recovery beyond the notable recovery, contributing 2.9 percentage pandemic, a new set of challenges confronted points to regional economic growth in 2021, the region. Output for the Western Balkans although performance was more mixed across has now surpassed pre-pandemic levels, but the region due to a more sluggish performance the response to the COVID-19 pandemic has in Bosnia and Herzegovina and Montenegro. resulted in higher public debt and has left lasting Exports also roared back across the region as scars. Potential growth remains constrained global demand for tradables strengthened, but by the need for structural reforms to boost net exports subtracted 0.7 percentage points productivity, increase competition, invest in from growth as in parallel import demand human capital, and strengthen governance. surged faster than exports, in line with strong Even before the Russian invasion of Ukraine, domestic consumption and investment, as higher energy prices and the challenges of the well as high import content of exports in some green transition were putting the Western countries. Balkans under stress. The war is now sending shockwaves across the region, particularly A return to growth saw significant job through higher energy and food prices but also creation, helping to reverse some of adverse via a disruption in trade and investment flows, impact of the pandemic. Rapid growth in putting the region’s recovery at risk. Careful 2021 saw the creation of 227,300 new jobs policy support within a more constrained fiscal in the Western Balkans. Strong domestic and space will be needed to navigate the Western external demand, coupled with a resumption Balkans through the next set of challenges. in tourism and construction, helped drive the employment rate to a historical high of The economies of the Western Balkans 45.8 percent of the working-age population, up saw a strong growth rebound in 2021 with 0.9 percentage points from 2020. Job creation a broad-based bounce back in economic was strongest for women and youths, who work activity. In 2021, GDP growth in the Western disproportionately in the services sectors, which Balkans reached 7.4 percent after a contraction were most affected by the pandemic. However, of 3.2 percent in 2020. The strength of the unemployment in the Western Balkans also rose recovery exceeded initial projections (from the at the same time to 13.7 percent in 2021, as Fall 2021 Regular Economic Report), and real labor market support programs were gradually GDP is now expected to surpass pre-pandemic wound down and people re-entered the labor levels by 2022, with only Montenegro expected market after pandemic-induced inactivity. to reach pre-pandemic output in 2023. Growth Nevertheless, labor force participation rates was driven by an exceptionally strong rebound remain low across the region, particularly for in consumption, contributing 5.3 percent to women, and the youth unemployment rate at the region’s growth rate, helped by fiscal stimuli, 33.2 percent at the end of 2021 remains high. pent-up demand, and a relaxation in movement 2  |  1. Overview STEERING THROUGH CRISES Employment demand helped reduce poverty guaranteed debt-to-GDP ratio declining from across all six Western Balkan economies. 60.8 percent of GDP in 2020 to 56.5 percent The poverty rate is estimated to have fallen of GDP in 2021, with Montenegro making the by 2.9 percentage points in 2021, reversing largest adjustment. the 1.4 percentage points increase in poverty of 2020. This is equivalent to 408,000 people Inflation is on the rise due to a combination being lifted out of poverty in 2021, meaning of factors. Stronger global growth since that net poverty has now fallen below pre- mid-2020 has placed upward pressure on pandemic levels. The strongest reduction in commodity prices and shipping costs, feeding poverty was in Albania and Kosovo. However, through into higher imported inflation across rising energy and food prices are expected to the Western Balkans. Similarly, strengthened weigh heavily on low-income households in the domestic demand in 2021 placed further Western Balkans, which spend a much higher pressure on prices. Core inflation in the Western share of their income on basic needs such as Balkans reached a record high of 2.9 percent in food and heating. December 2021, as persistent supply shocks and wage increases fueled inflationary expectations. Strong revenue performance helped reduce The conflict between Russia and Ukraine has fiscal deficits across the region. For most added significant further impetus to already economies in the Western Balkans in 2021, rising inflationary trends, driving energy and the buoyant recovery in economic activity food prices sharply upwards. Consumer price together with higher inflation fueled a nominal inflation growth in January 2022 ranged growth in revenues that outpaced expenditures. from 3.7 percent in Albania to 8.2 percent in The average deficit for the region dropped Serbia. In all countries, food and nonalcoholic by 4 percentage points of GDP compared to beverages price inflation contributed the most 2020. Montenegro, Kosovo and Serbia saw to headline inflation, with increases ranging sharp declines in the size of deficits. In North from 6.7 percent in Albania to 13.5 percent in Macedonia and Albania, the pace of fiscal Serbia. Increases in wages across the region may consolidation was more modest due to higher fuel price pressures further in 2022. spending, while in Bosnia and Herzegovina the fiscal shortfall widened due to higher wages Financial stability remains sound due to and social transfers that spilled over from support measures, but vigilance will be 2020. Public expenditure contracted (except needed given exceptional uncertainty. in Bosnia and Herzegovina) but remains above The financial systems of the Western Balkan pre-pandemic levels (except in Montenegro). economies have remained resilient through the Pandemic-related fiscal support, especially pandemic, with adequate capital and liquidity on transfers and subsidies, has been gradually buffers and the maintenance of asset quality. unwound, although governments are now Policy support, including borrower relief facing increased pressure to finance energy- and measures, coupled with a growth recovery has food-related subsidies. A healthy combination helped reduce banking sector risks and even of higher growth and lower deficits helped increase commercial bank profitability. The reduce public debt ratios across the Western imposition of financial sanctions on Russia Balkans, with the average public and publicly had a direct impact on the Western Balkans 1. Overview  |  3 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 with the takeover of subsidiaries of Russian implications for investments into and demand banks operating in Serbia and Bosnia and from the Western Balkans, and for the flow of Herzegovina. Wider macro-financial risks remittances. include indirect transmission channels from European banking groups active in the Western The economies of the Western Balkans Balkans, which are exposed to Russia and now face an unusually uncertain outlook. Ukraine. The Western Balkans also need to get Growth was already expected to slow as the prepared to manage the physical and transition region’s economies closed the pandemic- climate risks through gradually greening its induced output gap in 2021 and saw their financial sector. growth rates returning to the weak pre-crisis rates of potential growth in 2022 and beyond. There was especially strong growth in trade in Similarly, inflation was already rising before 2021 as the region benefited from a recovery the outbreak of hostilities. Russia’s invasion of in global demand, but the conflict between Ukraine, and the related economic implications Russia and Ukraine is expected to disrupt of the conflict, will exacerbate these two this trend. Exports surged by 39.2 percent trends, placing further downward pressure and imports by 29.0 percent in 2021, as the on growth and upward pressure on prices. In economies of the Western Balkans profited such an uncertain period, economic forecasting from a strong and broad-based recovery in becomes especially challenging. However, the demand for the region’s goods and services. baseline projection for GDP growth in 2022 As a result, current account deficits narrowed in the Western Balkans is now 3.1 percent, a in many countries (Albania, Bosnia and downward revision by almost 1 percentage Herzegovina, and Montenegro). The deficit was point (Table 1.1). broadly unchanged in North Macedonia, and somewhat higher in Serbia and Kosovo as rapid Risks are heavily tilted to the downside. expansion in consumption pushed imports up COVID-19 remains a concern, and the faster than exports. emergence of new and more infectious variants could trigger disruption, especially given the There are several channels of impact from sizable vaccination gap that remains between the war in Ukraine on the economies of the populations in the Western Balkans and Western Balkans. Among these, it is certain advanced economies. An expanded conflict or that inflation will be even higher, because of prolonged war between Russia and Ukraine additional increases in food and energy prices, could trigger further disruptions to global trade and that lower exports, disruptions in supply and to energy and food prices. Refinancing chains, and lower tourism revenues would also risks could arise if external financial market likely lead to a slowdown in growth. Direct conditions continue to tighten. Debt trade and investment linkages with Russia and sustainability may become a concern if limited Ukraine are more limited, except in Serbia fiscal space is eroded by policy responses to and Montenegro. A broader shock to business higher energy and food prices. Risks of political confidence across Europe would also have polarization also remain. 4  |  1. Overview STEERING THROUGH CRISES Table 1.1. Western Balkans Outlook, 2019–2024 2019 2020 2021p 2022f 2023f 2024f Real GDP Growth (percent) Albania 2.2 -3.5 8.5 3.2 3.5 3.5 Bosnia and Herzegovina 2.8 -3.1 7.1 2.7 3.1 3.5 Kosovo 4.8 -5.3 9.1 3.9 4.3 4.2 North Macedonia 3.9 -6.1 4.0 2.7 3.1 3.2 Montenegro 4.1 -15.3 12.4 3.6 4.7 3.7 Serbia 4.3 -0.9 7.4 3.2 2.7 2.8 WB6 3.7 -3.2 7.4 3.1 3.1 3.2 Real GDP Components Growth (percent) Consumption 3.1 -1.3 5.3 3.1 2.9 2.8 Investment 2.4 -1.5 2.9 1.0 1.1 1.3 Net exports -1.6 -0.4 -0.7 -0.9 -0.9 -0.9 Exports 3.8 -5.9 11.8 3.1 3.1 3.2 Imports (-) 5.4 -5.4 12.5 4.0 4.0 4.0 Consumer Price Inflation (percent, period average) 1.5 0.9 3.3 6.3 3.8 2.8 External Sector (percent of GDP) Goods exports 28.5 27.6 32.0 31.5 31.9 32.8 Trade balance -13.6 -13.6 -12.8 -13.4 -12.7 -11.8 Current account balance -6.2 -5.7 -4.9 -6.3 -5.6 -5.0 Foreign direct investment 4.8 5.3 5.7 5.0 5.2 5.2 External debt 76.7 90.6 85.0 92.0 90.2 89.3 Public Sector (percent of GDP) Public revenues 35.5 34.9 36.2 35.4 35.5 35.5 Public expenditures 36.9 42.2 39.5 39.2 38.1 37.4 Fiscal balance -1.3 -7.3 -3.3 -3.8 -2.6 -1.9 Public and publicly guaranteed debt 50.3 60.8 56.5 55.7 55.7 55.3 Sources: National statistical offices; Ministries of Finance; central banks; World Bank staff estimates. Note: p = preliminary; f = forecast. In such an environment, policy needs increase progressivity should be a priority across to focus on building resilience and on the Western Balkans as much as building energy undertaking structural reforms to support resilience through investing in renewables and growth and steer through the crises. With energy efficiency. Policymakers will also need limited fiscal space, countries will need to to resist the temptation to impose restrictions carefully weigh the costs and benefits of new on trade, especially on food, which would spending commitments in response to higher cause market distortions. Structural measures energy and food prices and prioritize vulnerable to reduce business regulatory costs, increase households. Measures need to be targeted and market competition, support labor market timebound. Improving tax compliance and participation, and strengthen the independence 1. Overview  |  5 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 of public institutions would all be supportive of growth in an uncertain environment. Higher growth would help alleviating debt sustainability concerns ahead of financial markets tightening. 6  |  1. Overview STEERING THROUGH CRISES 2. Western Balkan economies have rebounded fast in 2021 The Western Balkan economies rebounded Real GDP in some of the countries in the strongly from the crisis. The region region is predicted to catch up in 2022 with experienced higher growth in 2021 compared the level it would have reached without the to EU countries, despite a more moderate pandemic. The region is experiencing a fast economic recession caused by the pandemic economic recovery as real GDP in 2021 is close in 2020. Growth in the Western Balkans to its long-term trend level (Figure 2.2). Real rebounded to 7.4 percent in 2021 after GDP in 2021 surpassed its pre-pandemic level contracting 3.2 percent in 2020. The recovery in Albania, Bosnia and Herzegovina, Kosovo, was 1.5 percentage points stronger than and Serbia. Given the relatively modest 2020 initially projected in October 2021 (Figure recession and strong recent growth, Serbia 2.1). Overall, real GDP growth exceeded stands out with a 6 percent higher real GDP 4 percent in 2021 in all Western Balkan in 2021 relative to 2019. At the same time, countries. The rebound was most pronounced Montenegro’s 15 percent decline in economic in Montenegro totaling over 12 percent due activity in 2020 and North Macedonia’s more to the revival in tourism revenues. The strong modest economic recovery in 2021 mean growth of 9 percent in Kosovo and Albania that neither country’s real GDP levels has was also driven by a sharp rebound in travel yet reached their pre-pandemic level. In part receipts and government spending. Private because of the significant adverse impact of consumption has been supporting economic the war in Ukraine on the summer tourism activity in Serbia, Bosnia and Herzegovina, and season, Montenegro is the only Western Balkan North Macedonia, with total growth of 7.4, country whose real GDP is predicted to recover 7.1, and 4 percent, respectively. to its pre-pandemic level only in 2023. Figure 2.1. The economic recovery was strong Figure 2.2. Real GDP level in the Western throughout the Western Balkan countries in Balkan region is predicted to recover in 2022 2021 to its pre-COVID trend Percent 16 135 12 130 7.4 8 125 3.7 3.1 4 120 0 115 -4 -3.2 110 -8 105 -12 -16 100 14 15 16 17 18 19 23 20 22 21 20 20 20 20 20 20 20 20 20 MNE ALB KOS SRB MKD BIH WB6 EU27 20 J 2019 J 2020 J 2021p J 2022f ▬ Real GDP pre-COVID trend ▬ Real GDP actual, predicted Source: National statistical offices; Eurostat; World Bank staff estimates. Source: National statistical offices; World Bank staff estimates. Note: Based on real GDP pre-COVID linear trend growth 2013–19. 2. Western Balkan economies have rebounded fast in 2021  |  7 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Figure 2.3. The recovery was driven by a Figure 2.4. Consumption’s contribution to strong rebound in consumption and tourism growth in 2021 was well above recent historic averages Contribution to growth, percentage points, 2021p Contribution to growth, percentage points, 2012–19 18 6 15 12 3 9 3.9 6 2.5 2.1 2.0 3 4.5 6.0 4.5 5.7 4.9 5.0 0.6 0 0 -3 -6 -3 MNE KOS ALB SRB BIH MKD KOS MNE MKD ALB SRB J Consumption J Investment J Net exports Q Real GDP growth (percent) J Consumption J Investment J Net exports Q Real GDP growth (percent) Sources: National statistical offices; World Bank staff estimates. Sources: National statistical offices; World Bank staff estimates. The growth in Western Balkan countries was Investment contributed 2.9 percentage driven by an exceptionally strong rebound of points to economic growth in the region private consumption paired with high fiscal in 2021. The strong average contribution, stimuli. Private consumption contributed however, masks significant differences across the 5.3 pp to the region’s economic growth. Its six countries (Figure 2.3). The contribution of growth contribution exceeded 5 pp in Kosovo, investment to growth exceeded 3 pp in Albania, North Macedonia, and Serbia (Figure 2.3). It Kosovo, and Serbia. In Kosovo, it was spurred was strongest in Kosovo where consumption by credit expansion to private sector investment growth was fueled by restored consumer and higher real estate foreign direct investment. confidence, fewer mobility restrictions, In Serbia, real investment soared by almost a double-digit credit expansion, higher 15 percent, primarily driven by the surge in remittances, and a significant fiscal stimulus. government investment of up to 37.5 percent Similarly, private consumption surged in North in real terms. In contrast, investment hardly Macedonia and Serbia after the relaxation of grew in Bosnia and Herzegovina due to higher mobility restrictions while strong government costs of materials, and continued supply- consumption also contributed to growth. The chain disruptions, while in Montenegro it contribution of consumption to economic dragged growth by 5.5 pp due to lower public growth is well above its historic pre-pandemic investment. In all Western Balkan countries, levels in all Western Balkan countries (Figure the higher costs of energy and materials are 2.4)—it is at least twice as high in Albania, expected to weigh on private investment in North Macedonia, and Serbia. Strong private 2022. Public investment contributed strongly consumption fueled by household lending and to economic activity in several Western Balkan paired with strong government consumption countries in 2021 (Box 2.1), which may change will be difficult to sustain in 2022. in 2022 as public resources are redirected towards addressing the impact of energy crisis. 8  |  2. Western Balkan economies have rebounded fast in 2021 STEERING THROUGH CRISES Net exports subtracted 0.7 pp from economic A strong rebound in services spearheaded growth in the region due to the recent the economic recovery. The recovery was surge in import prices. Higher commodity broad-based across economic activities, except prices and a favorable external environment for agriculture. In Kosovo and Serbia, a in general supported export growth in all decline in agricultural output due to weather- Western Balkan countries. Fueled by the related shocks subtracted from growth. While strong consumption rebound and high energy, construction declined in North Macedonia material cost, and food prices, the growth and Montenegro, higher industrial activity in imports overshadowed in some cases the added to growth in most countries. Across recovery in gross exports (Figure 2.3). One the region, real GDP growth was driven by of the exceptions is Montenegro, where net service sectors. Retail trade expanded strongly exports soared due to tourism revenues that in all countries, mirroring the strong rebound rose more than six-fold relative to 2020. The in private consumption. The sharp rise in contraction in net exports was especially strong tourism and transport after the relaxation of in North Macedonia and Serbia, whose export mobility restrictions also fueled services growth structures are based on manufacturing, such as in the Western Balkans, especially in Albania, automobiles and automobile parts. The rise in Kosovo, and Montenegro. ICT services further imported material costs and continued supply contributed to growth in North Macedonia. chain disruptions weighed on net exports in both countries. Box 2.1. How much did the fiscal expansion contribute to the economic recovery? The COVID-19 pandemic prompted an unprecedented fiscal stimulus by governments across the world, including in the Western Balkans. The scale of support has varied across countries, depending on the depth of the crisis but also on the available fiscal space. In the Western Balkans region, public spending in 2020 increased by an average of 6 percentage points of GDP year on year, above 9 percent nominally.1 The size of the fiscal packages ranges from 2.6 percent of 2020 GDP in Albania to above 8 percent of 2020 GDP in Serbia, reflecting different needs but also different starting fiscal positions.2 The impact of fiscal spending has been stronger, yet delayed, compared to previous episodes. Government spending multipliers measure the change in output in response to a change in spending. The analysis estimates total expenditure multipliers for three selected regions–the European Union, 7STEEs, and the Western Balkans3—using a local projection model (Jordà, 2005).4 The dataset spans 1980 to 2020. Given limited data, the results should be treated as indicative, and further robustness analysis would be needed to more precisely quantify the impact of overall spending and its components. In line with existing literature, across the three regions the size for the fiscal multiplier 1 WB6 RER Spring 2021. 2 IMF Fiscal Monitor: Database of Country Fiscal Measures in Response to the COVID-19 Pandemic. July 2021 Database. 3 The selected regions are the European Union, the Western Balkans, and the 7STEEs, including Estonia, Latvia, Lithuania, Bulgaria, Croatia, Slovak Republic, Slovenia. 4 Jorda, O. 2005. Estimation and Inference of Impulse Responses by Local Projections. American Economic Review, 95 (1): 161 – 82. 2. Western Balkan economies have rebounded fast in 2021  |  9 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Box 2.1 continued associated with total expenditure is below 1 and ranges from 0.2 to 0.4 on impact to 0.4 to 0.6 at three-years’ time horizon. Figure 2.5 shows the estimate of the fiscal multiplier for total expenditure after two years for the three regions. Figure 2.6 shows the difference in the fiscal multiplier at impact and after a year, estimated with and without accounting for the 2020 crisis and the associated fiscal expansion. The fiscal multiplier on impact has been more compressed than historically, while the impact one year after has been larger. This may be because the drop in aggregate demand in 2020 was not primarily driven by deleveraging but rather by lockdown restrictions due to health precautions. In this sense, the restrictions imposed to slow the spread of the virus might have delayed the effects of adopted fiscal measures.5 Figure 2.5. The fiscal multiplier for total Figure 2.6. The fiscal impact after one year expenditure remains below one has been larger than historically Total expenditure multiplier after 2 years Difference in total expenditure multiplier for Western Balkan countries, with and without 2020 data 1.2 0.08 0.06 1.0 0.04 0.8 0.02 0.6 0 -0.02 0.4 -0.04 0.2 -0.06 0 -0.08 Western Balkans EU 7STEEs t0 t1 Notes: Bars measure standard multipliers, i.e., change in output in Notes: Change in the multiplier for government spending, with and response to a change in spending after two years. Black lines denote without 2020. 90% confidence intervals. Source: Authors’ calculations based on WEO data; estimation sample in Source: Authors’ calculations based on WEO data. Estimation sample in this case is 2000–2020. this case is 2000–2020. The combination of the automatic stabilizers and discretionary measures contributed to the strong response in 2020 in the Western Balkan countries. To assess whether governments responded proactively to the business cycle, the automatic features built into the tax and expenditure systems (such as a fall in tax revenues or a rise in unemployment benefits when the economy is in crisis), known as automatic stabilizers, should be distinguished from the discretionary actions, namely the fiscal impulse. As shown in Figure 2.7, there is a large variation across the six countries and across time. However, in 2020, all countries reacted strongly to the downturn, jointly through automatic and discretionary features of the fiscal framework. Figure 2.7 shows that historically, fiscal impulses (in red) tend to be positive when the economy was already booming, and negative when the economy was in a downturn, hence ending up accentuating cycles, but with some exceptions such as Albania after the global financial crisis. Automatic stabilizers (in green) should automatically react to the business cycle, with revenues decreasing and some spending increasing in times of crisis, the relatively small size of which, observed in some episodes like Serbia in 2020, points to the need to reinforce the automatic features of the tax and expenditures systems. 5 Auerbach, A J, Y Gorodnichenko, P McCrory and D Murphy (2021a), “Fiscal Multipliers in the COVID19 Recession”, CEPR Discussion Paper 16754. 10  |  2. Western Balkan economies have rebounded fast in 2021 STEERING THROUGH CRISES Box 2.1 continued Figure 2.7. Fiscal impulse, automatic stabilization, and output gap In percent of GDP, unless otherwise stated (rhs = inverted scale) Albania Bosnia and Herzegovina 10 -10 10 -10 8 -8 8 -8 Expansionary Expansionary fiscal stance fiscal stance 6 -6 6 -6 4 -4 4 -4 2 -2 2 -2 0 0 0 0 Contractionary fiscal stance Contractionary fiscal stance -2 2 -2 2 -4 4 -4 4 -6 6 -6 6 -8 8 -8 8 -10 10 -10 10 20 0 20 1 20 2 20 3 20 4 20 5 16 20 7 20 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 16 20 7 20 8 20 9 20 6 20 7 08 20 9 20 20 6 20 7 08 20 9 20 1 1 1 1 0 0 1 1 1 1 1 1 1 1 1 1 0 0 0 0 1 1 1 1 20 20 20 20 20 20 Kosovo Montenegro 10 -10 10 -10 8 -8 8 -8 Expansionary Expansionary fiscal stance fiscal stance 6 -6 6 -6 4 -4 4 -4 2 -2 2 -2 0 0 0 0 Contractionary fiscal stance Contractionary fiscal stance -2 2 -2 2 -4 4 -4 4 -6 6 -6 6 -8 8 -8 8 -10 10 -10 10 20 0 20 1 20 2 20 3 20 4 20 5 16 20 7 20 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 16 20 7 20 8 20 9 20 6 20 7 08 20 9 20 20 6 20 7 08 20 9 20 1 1 1 1 0 0 1 1 1 1 1 1 1 1 1 1 0 0 0 0 1 1 1 1 20 20 20 20 20 20 North Macedonia Serbia 10 -10 10 -10 8 -8 8 -8 Expansionary Expansionary fiscal stance fiscal stance 6 -6 6 -6 4 -4 4 -4 2 -2 2 -2 0 0 0 0 Contractionary fiscal stance Contractionary fiscal stance -2 2 -2 2 -4 4 -4 4 -6 6 -6 6 -8 8 -8 8 -10 10 -10 10 20 0 20 1 20 2 20 3 20 4 20 5 16 20 7 20 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 16 20 7 20 8 20 9 20 6 20 7 08 20 9 20 20 6 20 7 08 20 9 20 1 1 1 1 0 0 1 1 1 1 1 1 1 1 1 1 0 0 0 0 1 1 1 1 20 20 20 20 20 20 J Fiscal impulse (∆ cyclically adjusted primary balance), rhs /1 ▬ Output gap (real output gap in percent of potential real GDP), lhs J Automatic stabilizers (residual: ∆ primary balance - ∆ cyclically adjusted primary balance), rhs /2 Notes: Methodology based on Abdih, Y., Lopez-Murphey, P., Roitman, A., and R. Sahay (2010), “The Cyclicality of Fiscal Policy in the Middle East and Central Asia: Is the Current Crisis Different”, IMF Working Paper. Sources: IMF World Economic Outlook, October 2021, and World Bank staff calculations. 2. Western Balkan economies have rebounded fast in 2021  |  11 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 3. Labor market recovery faces headwinds The growth recovery and mostly services trade, ICT, and transport. The construction sectors helped create 245,000 new jobs in sector also observed an increase in employment the Western Balkans in 2021 compared to across countries, except in North Macedonia. pre-crisis 2019.6 While countercyclical and Employment in agriculture continued to shrink, discretionary measures undertaken in 2020 in except in Bosnia and Herzegovina and Kosovo. response to the crisis helped mitigate major job Yet, from the last quarter of 2021, North losses, the growth recovery in 2021 has had Macedonia and Serbia observed a slowdown in a much stronger job creation impact (Figure employment growth, an early sign of the global 3.1). In Bosnia and Herzegovina, Serbia, and energy crisis impact on their export industries. Kosovo, the number of employed in 2021 Services that are an engine of growth in many well surpassed the 2019 level. Employment in middle-income countries (Box 3.1) struggled Albania, North Macedonia, and Montenegro, throughout 2021 in North Macedonia. despite wage subsidies kept in place until early 2021 for harder-hit sectors, remained In 2021, the Western Balkan employment below the pre-crisis level. From mid-2021, rate increased to a historical high of public sector employment, industry, and 45.8 percent, an expansion of 0.9 percentage services led the job market recovery (Figure points from 2020. The largest increase in 3.2). During the summer, the tourism sector the employment rate was observed in Kosovo boosted employment, followed by a rise in (4.2 percentage points), due to gains in formal Figure 3.1. Employment recovered from mid- Figure 3.2. …led by public sector, industry, 2021... and services. Two-quarter average y/y growth, percent Change in employment, percent, y/y 10 40 14 12 8 30 10 6 8 20 6 4 4 2 10 2 0 0 -2 0 -2 -4 -10 -6 -4 -8 -6 -20 -10 -12 Ju 20 Ju 21 M -20 Se l-20 No -20 Ja -20 M -21 Se l-21 No -21 21 M r-20 M r-19 Ju 19 Se l-19 No -19 Ja -19 M r-21 General - - v- - n ay ay p v p n ay p v Agriculture Industry Construction Services government a a a M ▬ ALB ▬ MKD ▬ SRB ▬ WB6 ▬ BIH, rhs ▬ MNE, rhs ▬ KOS, rhs J Q2-20 J Q3-20 J Q4-20 J Q1-21 J Q2-21 J Q3-21 J Q4-21 Sources: National statistical offices; World Bank staff estimates. Sources: National statistical offices; World Bank staff estimates. Note: 2019–20 data for Bosnia and Herzegovina lack comparability due to methodological changes. 6 This analysis was affected by (1) now discontinued publishing of Labor Force Survey (LFS) data in Kosovo since Q 2021; (2) discontinued publishing of sectoral employment data in Albania; and (3) a sampling revision in Bosnia and Herzegovina and Montenegro that reduced comparability with previous LFS data. Using administrative ta register, employment, and unemployment data helped approximate what happened with labor market in 2021 in Kosovo, as well as in Albania. 12  |  3. Labor market recovery faces headwinds STEERING THROUGH CRISES Box 3.1. Services to the rescue: A labor market perspective Owing to the manufacturing-led economic miracle of East Asia, the potential of the service sector to revamp labor markets and stimulate income convergence of low- and middle-income countries (LMICs) has been questioned by many and, as a result, has been left largely untapped. The nature of services is also changing with the advent of technology and is heterogenous, using labor from the entire skills spectrum. In fact, services have taken center stage on the development path, and this trend also holds for the Western Balkans, mirroring that observed in most LMICs. Services employment is around 60 percent of total employment across the Western Balkans, and the share is consistently increasing over time. On average, the share of the service sector in total employment for the region is more than twice the share of industry and more than four times the share of agricultural employment. However, the regional average masks large within-region differences, with the average share of services employment being at 42.5 percent in Albania and as high as 81.4 percent in Montenegro (Figure 3.3). Over time, the share of services employment increased steadily across all six Western Balkans countries, most notably in North Macedonia, by 4 percentage points since 2016. Figure 3.3. The service sector is an Figure 3.4. …in the Western Balkans important employer… focused on low-skill sectors. Employment share by sector of activity, percent Share of services employment by type of service, percent 81.4 Montenegro 1.1 17.5 53.1 67.4 Kosovo 4.5 28.2 Bosnia and 66.3 31.2 Herzegovina 2.4 57.2 Serbia 16.4 26.4 North 54.2 30.8 Macedonia 14.9 Western 51.3 25.7 13.0 Balkans 23.0 42.5 Albania 19.8 37.7 33.9 0 10 20 30 40 50 60 70 80 90 J Services J Industry J Agriculture J Low-skill services (domestic and tradeable) J Skill-intensive social services J Global-innovator services Sources: National statistical offices. Employment data by sector of activity/type of service is obtained from either labor force surveys or administrative sources (average for the period 2016–2020). Classification of services by type follows Nayyar, Hallward-Driemeier and Davies (2021). In the Western Balkans, more than half of service sector employment is in low-skill services (Figure 3.4). Services differ in terms of labor skills required, accessibility to foreign markets, offshorability, innovation capacity, capital intensity, and intersectoral linkages. Low-skill services include a range of services7 and vary greatly in terms of employment share. An outlier in the share of low-skill services in total services employment is wholesale and retail trade, where more than 25 percent of low-skilled employment is concentrated in the Western Balkans. This pattern is consistent with the identified “first wave” of services sector growth across LMICs, consisting primarily of traditional services, like trade ad transport, as countries move from low to middle-income status.8 7 Transportation and storage, wholesale and retail trade, accommodation and food, administrative and support services, real estate activities, arts, entertainment and recreation and other service activities. 8 Eichengreen and Gupta, 2011. 3. Labor market recovery faces headwinds  |  13 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Box 3.1 continued However, over 30 percent of total services employment in the Western Balkans is in skill-intensive social services9  which include jobs which are predominantly in the public sector. Only 13 percent of total services employment is in global innovator services,10 producing more than 20 percent of the real value added in the economies of the Western Balkans. Global innovator services receive the Figure 3.5. The largest number of employees highest gross wages, with skill-intensive is in low-skill services social services being in the middle of the Wages and employment by type of service distribution. Although employees in ICT and Gross wage, in EUR finance and insurance activities constitute only 1,200 7.5 percent of total services employment, they 1,000 are paid more than twice the wages of employees Global innovator series in wholesale and retail trade (Figure 3.5). 800 Skill-intensive social services However, finance and insurance activities also 600 Low-skill services embody the greatest variation across services 400 (tradeable) Low-skill services (domestic or tradeable) wages in the region, with the highest wages for Low-skill services (domestic) 200 these services being paid in Montenegro, and the lowest wages being paid in Kosovo, where 0 0 5 10 15 20 25 30 this sector is yet to be developed. On the other Share of services employment end, the lowest gross wage in the Western Balkan economies is paid for transportation Sources: National statistical offices. Classification of services by types follows Nayyar, Hallward-Driemeier, and Davies (2021). Albania is and storage services, with Montenegro being excluded because of lack of detailed services data. an exception. The services sector has become an important growth contributor in the Western Balkans, expanding job opportunities and improving living standards for workers in this region. While increased employment concentration in low-skill services was linked to minimum barriers to entry for workers, and to more opportunities for women, informal, and agricultural workers, these services have a limited potential to reduce productivity gaps with higher-income economies in the long run. As Western Balkan countries move up on the income distribution ladder, the share of global innovator services in total employment should rise, generating more value-added and better employee compensation for people in the region. 9 Public administration, defense, education, human health, and social work activities. 10 Information and communication, financial and insurance activities, professional, scientific and technical activities. employment. According to the Kosovo Pensions and Herzegovina and Montenegro are outliers, Savings Trust, the number of active pension as the annual employment rate dropped in contributors increased by 10.7 percent year- both countries in 2021. on-year during the last quarter of 2021, which is about 40,000 formal jobs added compared In parallel with employment, the activity to the same period of 2020. Still, while Albania rate also rose due to women returning tops the region with the highest employment to the labor market. The inactivity rate rate of 52.9 percent, in Kosovo, despite recent dropped to 46.9 percent for the region (Figure gains, only 32.7 percent of the working-age 3.7), meaning that the region’s labor force population is employed (Figure 3.6). Bosnia participation rate increased to 53.1 percent, up 14  |  3. Labor market recovery faces headwinds STEERING THROUGH CRISES 1.3 percentage points compared to 2020. While The unemployment rate in the Western the participation rate of women is still lagging Balkans increased to 13.7 percent as more that of men, at the end of 2021, the female people started looking for jobs(Figure 3.9). participation rate increased to 42.5 percent As government support programs gradually (compared to men of 63.1 percent), an declined, some of the foreign-owned large increase of 1.3 percentage points from end- manufacturers closed their operations in 2020 (Figure 3.8). The largest improvement Serbia, resulting in significant layoffs. The was in Montenegro (5.3 percentage points) as unemployment rate in Serbia in 2021 H1 the tourism sector recovered. The female labor increased to 11.9 percent (compared to an force participation rate is still the highest in average of 9.2 percent in the same period of Albania at 53.9 percent (a new record), while it 2020) and declined only marginally during is below 24 percent in Kosovo. the rest of the year. The unemployment rate in Bosnia and Herzegovina also increased in Figure 3.6. The employment rate reached a Figure 3.7. …while inactivity dropped in four historical high in the Western Balkans… countries. Employment rate, 15+ years, percent, and 2021–20 change, Inactivity rate, 15+ years, percent, and 2021–20 change, percentage points percentage points 0.9 -1.3 WB6 WB6 4.2 -0.3 KOS ALB -0.5 0.4 BIH MKD -1.4 -2.5 MNE SRB 0.1 2.5 MKD MNE 1.5 -0.3 SRB BIH 0.3 -3.9 ALB KOS 0 9 18 27 32 45 54 20 24 28 32 36 40 44 48 52 56 60 64 J 2021 J 2020 J 2021 J 2020 Sources: National statistical offices; World Bank staff estimates. Sources: National statistical offices; World Bank staff estimates. Figure 3.8. More women returned to labor Figure 3.9. The unemployment rate declined market than men except in Bosnia and Herzegovina and Serbia Labor force participation, percentage change, latest 2021–2020 Unemployment rate, 15+ years, percent 80 30 70 25 60 50 20 40 15 30 10 20 10 5 2015 2015 2015 2015 2015 2015 Dec-19 Dec-21 Dec-19 Dec-21 Dec-19 Dec-21 Dec-19 Dec-21 Dec-19 Dec-21 Dec-19 Dec-20 0 ALB SRB MNE MKD BIH KOS KOS BIH MNE MKD ALB SRB Q Female LFP Q Male LFP J Unemployment rate (2020) ▬ Unemployment rate (2021) Q Unemployment rate (2019) Sources: National statistical offices data; World Bank staff calculations. Sources: National statistical offices data; World Bank staff calculations. 3. Labor market recovery faces headwinds  |  15 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 2021, by 1.5 percentage points to 17.4 percent, The increase in minimum wages comes compared to a year ago. In Montenegro, the at a time when firms are struggling with late start of the tourism recovery reduced rising commodity and energy costs at unemployment in the second half of the unprecedented rates. The corporate sector year. North Macedonia observed a continued still has not recovered from the impact of the decline in the unemployment rate but largely pandemic and supply chain disruptions and is on account of a decline in the activity rate—its already hit with a surge in input prices, ranging unemployment rate declined to 15.7 percent from raw materials to transport fuel. Defensive in 2021, the lowest since the measurement restructuring is already happening in the car was introduced in 2007. Youth unemployment supply industry through furloughs, but the declined as well, to 34.9 percent in Q4 2021, war in Ukraine, and the related sanctions on down by almost 5 percentage points year on Russia, will likely hurt the industry even more. year, but has not reached the pre-crisis level The car supply industry is a large employer in yet. Albania continues to have the lowest Serbia and North Macedonia, in particular. The youth unemployment rate—at 20.6 percent— pandemic and energy crises weakened corporate while, despite improvements, the youth balance sheets and could lead to a deterioration unemployment rate in Kosovo remains above of the hard-won gains in the labor market if 42 percent. such wage pressures persist. Higher minimum wages created wage Figure 3.10. Minimum wages increased in four pressures, which may postpone a decline countries in unemployment. In Montenegro, the gross Minimum to average wage ratio, percent 70 minimum wage rose by 43 percent (a net 60 increase of 80 percent) as the government 50 reformed payroll taxation, abolishing the health 40 insurance contributions. In North Macedonia, Serbia, and Albania, the government approved 30 minimum wage increases by 18.5 percent, 20 9.4 percent, and 6.7 percent, respectively. This 10 sharp rise in wages likely skewed wages toward 0 KOS MNE BIH MKD ALB SRB lower incomes, as firms try to mitigate labor J 2017 J 2019 J 2022 costs. In North Macedonia, the government Source: National statistical offices data; World Bank staff calculations. decided to compensate firms for higher labor costs due to the minimum wage rise. The ratio of minimum to average wage in the three countries is already above 60 percent of the average wage, which compares to the EU range of 35 to 50 percent (Figure 3.10). 16  |  3. Labor market recovery faces headwinds STEERING THROUGH CRISES 4. Poverty reduction has resumed, but further progress is uncertain Poverty fell in 2021 as the Western Balkan Figure 4.1. The region’s poverty rate declined economies experienced a robust recovery, in 2021, but there are significant risks for further reduction lifting an estimated 408,000 people out of Poverty headcount (percent of population living on less than poverty. The crisis caused by the COVID-19 US$5.5/day 2011 PPP) 30 pandemic in 2020 gave way to a strong economic recovery in 2021 as travel and trade 25 23.3 resumed and the population started gaining 20 19.7 17.7 access to the vaccine. Revived employment 16.3 14.8 14.2 15 13.6 and earnings contributed to reducing poverty. 13.8 12.9 After an estimated 1.4 percentage-point 10 increase in regional poverty in 2020 (Figure 5 4.1), equivalent to about 200,000 new poor, 0 in 2021 poverty is estimated to have fallen 2017 2018 2019e 2020e 2021e 2022f 2023f ▬ Baseline scenario ▬ Downside scenario by 2.9 percentage points, equivalent to about Source: World Bank estimates and projections based on 2018 income 408,000 fewer poor.11 Albania and Kosovo data from the Survey of Income and Living Conditions (SILC) for North Macedonia, Albania, Montenegro, 2019 for Serbia; and 2017 Household account for 82 percent of the regional poverty Budget Survey (HBS) data for Kosovo. Note: Income measures in the SILC and consumption measures in the decline, and their poverty rates are estimated HBS are not strictly comparable. Welfare is estimated in U.S. dollars using revised 2011 PPPs. The regional estimate excludes Bosnia and to now be below their 2019 levels. North Herzegovina due to lack of comparable data. e = estimate; f = forecast. Macedonia and Serbia experienced more particularly hospitality and trade. In Serbia, modest declines, and Montenegro and North a notable agricultural output decline likely Macedonia still have estimated poverty rates dampened the poverty reduction impact of an above their 2019 levels (Table 4.1). otherwise broad-based economic recovery. Job creation gained momentum at varying speed The economic rebound across countries had in 2021. It started picking up in the second heterogenous impacts on poverty in 2021, quarter and accelerated in the third quarter in reflecting variations in sectoral growth, Albania, Montenegro, and Serbia.13 In Kosovo, wages, and employment. The 2020 crisis although no nationally representative data are translated into job losses and possibly earnings available after the first quarter, tax registered reductions, especially in some sectors with high employment shows a significant increase. In shares of self-employed workers.12 In 2021, the North Macedonia, employment growth was strong growth rebound (from 4 percent in North modest, however. In some countries, a fiscal Macedonia to 12.4 percent in Montenegro) stimulus extended into 2021 continued to lift was driven in large part by the services sector, household income. 11 Poverty is defined as a person living on less than US$5.5 per day in revised 2011 purchasing power parity (PPP), with the exception of Bosnia and Herzegovina, due to a lack of comparable data. In May 2020, the 2011 PPP was revised (https://openknowledge.worldbank.org/bitstream/ handle/10986/33623/9781464815300.pdf ), resulting in revised estimates of poverty at US$5.5 per day. This revision reflects a reassessment of cost-of-living comparisons among countries but does not imply a real change in poverty within countries. 12 As of March 2022, there were no nationally representative data on earnings for 2020 in any of the Western Balkan countries; however, employment reductions were more pronounced in sectors with a higher share of self-employment, especially during 2020 Q2 and Q3. 13 Labor Force Survey data in Kosovo are only available up to 2021 Q1. 4. Poverty reduction has resumed, but further progress is uncertain  |  17 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Table 4.1. Poverty reduction at the country level is projected to slow in 2022, reflecting rising food and energy prices and impacts of the war in Ukraine Poverty estimates and projections (percent) Year ALB KOS MKD MNE SRB 2017 35.8 24.4 19.5 16.0 19.8 2018 32.4 23.3 17.9 16.9 14.3 2019 28.1 21.1 16.5 15.6 10.1 2020 31.3 23.2 18.3 19.9 10.2 2021 22.0 19.4 17.2 16.2 9.8 2022 19.4 17.6 16.4 15.6 9.6 2023 16.9 15.8 15.9 14.8 9.3 Source: Calculations based on ECAPOV (ECA Poverty database) harmonization using SILC-C data for Albania (ALB), North Macedonia (MKD), Montenegro (MNE), and Serbia (SRB), and HBS data for Kosovo (KOS). Note: Black = Actual. Orange=Nowcasted/projected. Income measures in the SILC and consumption measures in the HBS are not comparable. Poverty is defined as living on less than US$5.5 per day per person in revised 2011 PPPs. Bosnia and Herzegovina is excluded due to lack of comparable data. Rising global energy and food prices the EU demand for Western Balkan exports. combined with the impacts of the unfolding This possibility of slower growth in the EU war in Ukraine generate risks for poverty and rising transport costs may affect the ability reduction in 2022. Under the baseline scenario of the diaspora to maintain remittance flows of positive growth across the region, the poverty and travel to the Western Balkans. A downside rate for the Western Balkans is projected to fall scenario assumes that income growth will by about 1 percentage point to 13.8 percent in trail inflation even more than in the baseline 2022. However, there are downside risks. First, scenario, especially for lower segments of the food and energy prices increased faster than the population. It projects a smaller fall in poverty Consumer Price Index throughout the region of 0.6 percentage points.14 in the latter half of 2021 and are expected to rise even further in 2022, which reduces the Persistent inflation is of significant concern purchasing power of households, especially for the welfare of households in the region the poor and vulnerable. Moreover, aside from (Box 4.1). Rising energy and food prices  higher energy, food, and input prices, sanctions disproportionately hurt the poor, as they often on Russia could affect economic activity in spend a larger share of their budget on food countries and sectors with strong ties to Russia (Figure 4.2, Panel A) and have fewer ways to (such as tourism and hospitality, or real estate cope with rising food and energy prices. In and construction), in turn lowering household 2021, average food inflation already showed income growth in these sectors. Countries with a marked increase relative to 2015–20 (Figure migrants in Russia will experience declines in 4.2, Panel B). By December 2021, food remittance income. Finally, potential knock-on prices in the Western Balkan countries had effects on cost of living and economic activity increased 6.8 to 12.7 percent year on year. in the European Union (EU) may also lower While the overall inflation rate for 2022 is still 14 The downward scenario is projected for Albania and Kosovo, which account for over 80 percent of the poverty reduction in 2021. For Albania, it assumes a pass-through rate of 0.5 for GDP per capita growth to poverty reduction in 2022 (as household inflation outpaced official inflation). For Kosovo, a pass-through of 0.87 is assumed for 2022. 18  |  4. Poverty reduction has resumed, but further progress is uncertain STEERING THROUGH CRISES Figure 4.2. Food price inflation could significantly affect the purchasing power of poor households Panel A. Household consumption of food and non- Panel B. Average food inflation alcoholic beverages Percent final consumption expenditure Percent 78 80 6 70 4.9 63 5 60 4.2 52 52 3.8 3.8 4 3.7 3.6 50 44 44 42 3.1 39 40 34 3 2.7 32 30 28 30 2.0 2 1.7 1.6 1.5 20 1 0.6 10 0.3 0 0 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB WB6 J Average J Poorest decile J 2015–2020 J 2021 Sources: World Bank staff calculations using HBS data (Panel A) and official CPI statistics from national statistical offices (Panel B). Note: Years in Panel A: Albania and Serbia, 2019; Kosovo and North Macedonia, 2017; Bosnia and Herzegovina and Montenegro, 2015. unknown, governments across the region have bounced back strongly, and per capita GDP substantially adjusted minimum wages, which grew by 9 percent. Though employment has not could partially cushion the shock, although fully recovered, there is evidence of significant this might also stifle formal job growth in the income growth: 3.7 percent real growth for short term, at least, while possibly creating formal sector wages, 13 percent real minimum further price pressures over the medium term. wage growth, and 14.7 percent growth in However, inflation will bite into the incomes remittances, for example. Poverty is estimated of workers in the informal sector and those to have fallen dramatically to 22 percent. depending on non-labor income (pensions, Under a baseline scenario of historical inflation transfers if they are not inflation-indexed, patterns, it is projected to fall again in 2022 by or remittances), which could slow poverty 2.6 percentage points, going below 20 percent reduction. The implications of energy price of the population. However, rising inflation increases and government response measures could severely reduce real income growth are further discussed in the Spotlight section. among poor and vulnerable households and dampen poverty reduction. Poverty in Albania is estimated to have fallen significantly to 22 percent of the population After the rebound in economic growth in in 2021, but inflation could disrupt this 2021, household welfare could be affected trend. Between 2016 and 2019, income-based in Bosnia and Herzegovina due to slower poverty declined by 11.8 percentage points, economic growth and higher inflation. from 40 percent of the population to 28 percent, Economic growth has not translated into more as GDP per capita grew at 3.6 percent per year and better jobs in the past. As such, the poverty on average. In 2020, poverty is estimated to rate does not seem to have improved. The have increased by 3.2 percentage points due latest available data using the national poverty to the November 2019 earthquake and the line of KM 205 per capita per month are for COVID-19 pandemic. In 2021, the economy 2015, when the poverty rate was estimated 4. Poverty reduction has resumed, but further progress is uncertain  |  19 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 at 16 percent, very close to the 15 percent EU could affect the non-labor income of estimated for 2011. In 2020, the pandemic households in Bosnia and Herzegovina by caused substantial damage to the labor market. limiting remittances from those who have The slowdown in the economy and the emigrated, on which the country is particularly consequent loss of jobs and earnings have likely dependent (about 8 percent of GDP in 2020). eroded household welfare. The policy measures Higher prices, particularly for fuel and food, the government introduced to protect firms and are likely to have a disproportionally negative households prevented a worse impact on the effect on the less well-off, since the poor tend to labor market. Despite a renewed acceleration spend a greater proportion of their expenditure in COVID-19 cases toward the end of 2021 on these items and have limited mechanisms to and beginning of 2022, improvements in cope with higher inflation and preserve their the activity and employment rate continued purchasing power. until the end of 2021. Lower growth in the Box 4.1. The poor disproportionately feel the effects of inflation The Consumer Price Index (CPI) does not necessarily reflect the inflation felt by poorer households since their expenditure composition differs from that of the average household. Since the CPI tracks the cost of a representative basket of goods, the index should approximate the inflation felt by an average household, provided that the weights used in the CPI basket closely reflect the composition of the average household’s expenditure in the year. To examine how closely the CPI reflects inflation for the average household, we multiply the expenditure share of each category for the average household with the inflation reported for the respective category and add all weighted categories. As Figure 4.3 (left) shows, average household inflation is below but near the CPI in Bosnia and Herzegovina, Kosovo, Montenegro, and Serbia, but above the CPI in Albania and North Macedonia. Repeating this exercise for households in the poorest and richest deciles provides the inflation faced by these specific subgroups. The poorest decile households systematically experience higher inflation than the average and richest decile households (Figure 4.3, right). Moreover, in the case of Albania and North Macedonia, the CPI more closely reflects the consumption composition of the richest households than the average household. The higher inflation faced by the poor partly reflects their higher food share and food price inflation. For the average household in the Western Balkans, food is the largest expenditure category, varying between 28 percent of total expenditure in Serbia to 52 percent in Kosovo. This share is even higher among poorer households, which devote between 34 percent (Bosnia and Herzegovina) and 78 percent (North Macedonia) of their total consumption expenditures to food. According to the official CPI, across the region, in 2021 food prices increased faster than the total basket of goods tracked by the CPI in all countries except North Macedonia. Those on a lower income may perceive more pronounced increases in prices and the cost of living than what is captured by actual inflation. Consumers’ views tend to be more heavily shaped by the price changes of the items they see and purchase more frequently. Rising prices of everyday purchase items like food and fuel, which are significant expenses for the poor, are likely to have a strong influence on the perception of inflation. Low-income individuals, who are more often in informal work, also tend to feel a stronger pressure of the rising cost of living because their income growth is less likely to keep pace with rising prices. 20  |  4. Poverty reduction has resumed, but further progress is uncertain STEERING THROUGH CRISES Box 4.1 continued Figure 4.3. Poor households experienced higher inflation than average households in recent months CPI compared to average household inflation Household inflation in early 2022 at different consumption deciles 10 10 8.8 9.0 9 9 8.3 7.9 8.0 7.9 7.9 8.0 7.9 8 7.3 7.5 7.6 8 7.3 7.3 7.6 7 6.7 7 6.5 6.5 6.4 6.4 6.1 6.3 6.1 6 6 5.7 5.6 5 4.3 5 4.3 4.5 3.9 3.7 4 4 3 3 2 2 1 1 0 0 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB J Average J CPI J Average J Poorest decile J Richest decile Sources: World Bank staff calculations using HBS data and official CPI statistics from each country’s national statistical office. Note: Years for data on expenditure composition: Albania and Serbia, 2019; Kosovo and North Macedonia, 2017; Bosnia and Herzegovina and Montenegro, 2015. Inflation is year on year for the latest month with available CPI: February 2022 for all countries except for BIH, for which data are from January 2022. Poverty in Kosovo is estimated to have importer of both, and if diaspora travel and dropped to below its 2019 level in 2021, remittances fall and wages fall behind inflation, but for 2022 the downward trend is at risk. real incomes could be significantly reduced, During 2017–19, per capita growth averaged and poverty might not fall as projected. 4.1 percent annually and the (consumption- based) poverty rate fell from 24.4 percent in Following the robust recovery of 2021, 2017 to an estimated 21 percent in 2019. In poverty reduction in Montenegro is 2020, the crisis reversed this positive trend projected to slow significantly in 2022 due and GDP per capita dropped by 4.6 percent, to rising prices and risks of spillover impacts while poverty is estimated to have increased from the war in Ukraine. The COVID-19 by 2 percentage points. In 2021, the economy pandemic and the collapse of tourism and bounced back strongly and GDP per capita is related services caused a severe contraction of estimated to have increased by close to 9 percent, economic activity, estimated at 15.3 percent as diaspora travel resumed, construction in 2020, and reversed six years of poverty boomed, and manufacturing exports increased, reduction. Targeted wage subsidies and one-off while the impacts of early pension withdrawals cash assistance for vulnerable citizens helped the and other fiscal stimulus measures fueled country avoid even larger layoffs and increases consumption. The strong recovery is estimated in poverty, but vulnerable workers in the to have reduced poverty by 3.8 percentage informal sector might not have received much points to under 20 percent of the population. support. The strong recovery of Montenegro’s In 2022, projected growth of GDP per capita is economy in 2021, estimated at 12.4 percent 3.7 percent, and poverty is expected to decline and driven primarily by a rebound in tourism, further to 17.6 percent. However, growing led to an increase in employment and a decline inflation of food and energy prices can hit in unemployment. Poverty is estimated to have Kosovo especially hard as the country is a net increased by more than 4 percentage points to 4. Poverty reduction has resumed, but further progress is uncertain  |  21 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 about 19.9 percent in 2020 and then fallen to energy crisis and the war in Ukraine brought 16.2 percent in 2021. However, the outbreak new challenges. Growth is projected to slow of war in Ukraine and sanctions on Russia that in 2022, affected by the conflict and the followed have worsened the growth outlook for economic sanctions. Lower demand from the Montenegro in 2022, mainly due to an adverse EU and higher prices of energy, metals, food, impact on tourism, and is therefore expected to and agricultural inputs are expected to have an slow household income growth, particularly for impact on the economy. Inflation would likely those working in the tourism and hospitality exceed 5 percent despite government measures. sector. This, coupled with rising energy and Inflationary pressures (in particular, prices of food prices, limit the pace of poverty reduction energy and food) may increase the cost of living in 2022. and hurt the less well-off relatively more. As economic growth rebounded and poverty While Serbia weathered the COVID-19 resumed its decline, the energy crisis and pandemic without a large increase in the war in Ukraine brought new challenges poverty, it will be challenging to resume in North Macedonia. The country has made poverty reduction in 2022 due to new risks. considerable progress in reducing poverty since The government’s massive fiscal package of the 2008 global financial crisis. The poverty rate about 13 percent of GDP in 2020, including (based on the upper middle-income poverty wage subsidies for all sectors and a universal line of US$5.5 per day in 2011 PPP) fell from cash transfer, helped to cushion the immediate about 36 percent in 2009 to 18 percent in impact of the pandemic on the population and 2018, mainly driven by increased employment the economy. In 2021, Serbia’s economy grew opportunities and higher labor earnings. The by 7.4 percent, and the employment rate in the adverse effects of the COVID-19 crisis have second half recovered to surpass pre-pandemic reversed earlier employment gains in the levels, contributing to poverty reduction. These country. A simulation analysis estimated that positive developments were partly countered poverty increased by more than 1.5 percentage by an output decline in agriculture, rising points in 2020. The government provided inflation toward yearend, and the phasing support measures, including subsidies and out of government support programs. Poverty social security contributions to private sector is estimated to have declined only slowly in firms and cash benefits and vouchers for 2021, and new challenges in 2022 are expected vulnerable people, which to a certain extent to halt progress. The unfolding Ukraine- alleviated the negative poverty impacts of the Russia conflict will have an adverse impact on COVID-19 crisis. Poverty is estimated to have Serbia’s exports, FDI, remittances, and tourism resumed its decline in 2021. The labor market revenues, all of which will lower the prospects experienced a slow improvement that year. The for household labor and non-labor income unemployment rate decreased to 15.2 percent at growth. The immediate impact through rising the end of 2021, in part due to a small increase inflation will limit household purchasing in the employment rate, but also due to a lower power, and rising energy prices, in particular, activity rate. As the recovery progressed, the often disproportionately hit the poor. 22  |  4. Poverty reduction has resumed, but further progress is uncertain STEERING THROUGH CRISES 5. Continued need for fiscal support against limited space Fiscal deficits narrowed across the Western revenue collection. Revenues increased by Balkans, except in Bosnia and Herzegovina, an average of 1.3 pp of GDP for the region, as economies rebounded in 2021. For most surpassing pre-pandemic levels, while statutory Western Balkan countries, a buoyant recovery tax rates remained broadly constant. This is in economic activity fueled nominal growth in part due to the withdrawal of tax relief in revenues that outpaced expenditure growth measures used to counter the impact of the in 2021. The average deficit for the region pandemic in 2020 and the resulting increase in dropped by 4 percentage points (pp) of GDP effective taxation. In addition, higher revenues compared to 2020 (Figure 5.1).15 Bosnia and resulted from spillovers of fiscal measures on Herzegovina increased the deficit to 2.5 percent formalization efforts. That said, the exceptional of GDP, while Montenegro, followed by nominal increase in revenue is also attributed to Kosovo and Serbia, experienced sharp declines higher inflation that accompanied the rebound in fiscal deficits. North Macedonia has seen in economic activity, particularly for taxation a moderate reduction in its fiscal deficit as of imports. In Kosovo, Serbia, and Albania spending remained elevated and the rebound nominal revenue growth surpassed 20 percent remained slower than in other Western Balkan y/y, and including North Macedonia, provided countries. In Albania expenditures declined, the highest contribution in the reduction of while revenues rebounded, reducing the fiscal fiscal deficits in 2021 (Figure 5.2). deficit by 2.2 percentages point of GDP. Public expenditure contracted but remains In addition to the strong rebound in above pre-pandemic levels. Compared to economic activity, inflation increased 2020, expenditures declined in GDP terms in Figure 5.1. Fiscal balances improved across Figure 5.2. …supported by revenue growth the Western Balkan countries… and lower expenditures. Fiscal balance, pp of GDP Contribution to change in the fiscal balance, percent of GDP, 2021p 2 10 ↑Reduced revenues, increased spending 8 0 6 -2 -1.4 4 -2.0 -2.5 2 -4 -3.3 -4.1 0 -4.5 -6 -5.4 -2 -4 -8 -6 -8 -10 -10 ↓Increased revenues, reduced spending -12 -12 MKD ALB SRB BIH MNE KOS WB6 MNE KOS SRB MKD ALB BIH WB6 J 2019 J 2020 J 2021p J Expenditure J Revenue Q Change in fiscal balance Sources: National statistical offices; Ministries of Finance; World Bank staff Sources: National statistical offices; Ministries of Finance; World Bank estimates. estimates. 15 Unweighted average of fiscal deficit levels in Western Balkan countries. 5. Continued need for fiscal support against limited space  |  23 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 all countries except Bosnia and Herzegovina in the region continued to provide fiscal (Figure 5.3). However, despite a gradual support measures to varying degrees, at the withdrawal of pandemic-related fiscal support regional level, spending on social benefits fell measures, spending remains above the pre- by an average of 0.8 pp of GDP compared to pandemic level by an average of 2.6 percent 2020. The sharpest decline was recorded in of GDP owing to the persistence, albeit at a Montenegro, while in Bosnia and Herzegovina, lower level, of counter-pandemic measures and Kosovo and Albania social spending dropped energy subsidies. In contrast, for Montenegro, by only 0.2-0.3 pp of GDP. The surge in energy which experienced the strongest recovery, real prices intensified pressures for higher electricity expenditure decreased compared to pre-crisis subsidies in many Western Balkan countries, levels on account of higher savings on goods particularly in Albania, North Macedonia, and and services and capital under-execution Kosovo, slowing the consolidation in current due to delays in implementation and budget spending (please see the spotlight section for approval. In Bosnia and Herzegovina, the a further discussion of government measures paralysis in policy making contributed to a in response to the energy crisis). The wage bill slowdown in capital expenditures, but current declined by 0.7 pp of GDP on average but spending surged. Meanwhile, expenditures remains higher than its pre-pandemic level. In declined by 1.1 pp of GDP in Albania, despite Albania and Bosnia and Herzegovina spending higher infrastructure spending related to on wages decreased by 0.3 pp of GDP. In post-earthquake reconstruction and energy North Macedonia and Serbia, a decline was subsidies. 0.4 to 0.5 pp of GDP, respectively. In Albania, capital expenditures increased by 0.6 pp of The wage bill and social benefits spending GDP, driven by higher infrastructure and declined across Western Balkan countries, reconstruction spending, while Montenegro although pressures for higher energy saw a significant decline due to the delays in subsidies intensified. While governments highway construction (Figure 5.4). Figure 5.3. Spending on social benefits and Figure 5.4. Capital expenditures increased wages declined significantly in Serbia and Albania Percent of GDP Contribution to change, in percent of GDP 60 4 50 2 0 40 -2 30 -4 20 -6 10 -8 0 -10 2020 2021p 2020 2021p 2020 2021p 2020 2021p 2020 2021p 2020 2021p 2020 2021p -12 SRB MNE BIH MKD ALB KOS WB6 MNE KOS SRB MKD ALB BIH WB6 J Wage bill J Social benefits J Capital expenditures Q Total expenditures J Wage bill J Social benefits J Capital expenditures Q Total expenditures Sources: National statistical offices; Ministries of Finance; World Bank Sources: National statistical offices; Ministries of Finance; World Bank estimates. estimates. 24  |  5. Continued need for fiscal support against limited space STEERING THROUGH CRISES Figure 5.5. Public and publicly guaranteed Figure 5.6. …and so did external debt. debt declined in most countries, although it remains elevated… Percent of GDP Percent of GDP 120 120 100 100 80 80 60 60 40 40 20 20 0 0 MNE ALB MKD SRB BIH KOS WB6 MNE MKD ALB SRB BIH KOS WB6 J 2021p ▬ 2020 Q Pre-pandemic peak ‹ Pre-pandemic low J 2021p ▬ 2020 Q Pre-pandemic peak Sources: National statistics offices; World Bank staff estimates. Sources: National statistics offices; World Bank staff estimates. Public and publicly guaranteed (PPG) External PPG debt declined from its debt declined in terms of GDP but remains historical high of 41 percent of GDP in high. As nominal GDP rebounded faster than 2020 to 38.5 percent of GDP in 2021  (Figure expected in almost all economies in the region, 5.6). Montenegro has driven this decline as the average PPG debt to GDP declined from it repaid external debt (including the 2016 60.8 percent of GDP in 2020 to 56.5 percent Eurobond of €227 million) in the total amount in 2021 (Figure 5.5). The decline was most of 7.3 percent of GDP in 2021, bringing down prominent in Montenegro, where it amounted its external PPG to a still elevated 80 percent to 21 pp, as most of the 2021 financing needs of GDP. A decline in North Macedonia’s and were covered from the deposits accumulated Bosnia and Herzegovina’s external PPG debt through the Eurobond issuance in December as a percent of GDP was mainly driven by an 2020, with no need for new borrowing. PPG increase in the nominal GDP. Albania’s and debt as a percent of GDP also declined in Serbia’s external PPG, however, increased as Bosnia and Herzegovina, North Macedonia, both countries issued Eurobonds in 2021, and and Serbia, although marginally. Also, Albania’s in the case of Serbia, green bonds. In November PPG debt decreased by 1.9 pp despite raising 2021, Albania placed a €650 million Eurobond €650 million Eurobond issued in November with a maturity of 10 years and a record-low 2021, for addressing the 2022 financing needs. interest rate of 3.625 percent. The issuance Kosovo’s PPG debt has remained constant proceeds will be largely used to finance deficit as a result of the decline in the fiscal deficit. and debt repayments in 2022. Serbia’s external However, PPG debt in terms of GDP in PPG debt increased due to two Eurobond all countries remains above the 2019 levels, issuances—first a 10-year Eurobond worth particularly in North Macedonia, with PPG €1 billion in February 2021, and then a 15-year debt as a percent of GDP more than 10 pp and seven-year Eurobond worth €750 million higher in 2021 than in 2019. and €1 billion, respectively, in September 2021. The latter two also mark significant achievements—the €750 million Eurobond 5. Continued need for fiscal support against limited space  |  25 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 comes with the longest maturity for Serbia so improved the outlook from stable to positive in far, while the €1 billion Eurobond is the first December 2021; Fitch left North Macedonia European green Eurobond issued outside the with a negative outlook (Table 5.1). Yet, all EU, with a record-low interest rate of 1 percent countries have a non-investment speculative and a seven-year maturity. grade, with North Macedonia’s and Serbia’s rated as speculative and other countries in the Favorable financing conditions are likely to region rated as highly speculative grades. revert due to geopolitical tensions in Europe and the announced monetary tightening. Rebuilding fiscal space and maintaining Most Western Balkan countries have become fiscal prudence can help mitigate the increasingly reliant on external financing, and emerging risks. The surging energy and the monetary tightening in the United States food prices, further exacerbated by the war in and global geopolitical tensions are weighing Ukraine, have forced governments to provide on investors and have already resulted in support to households and businesses and to significant outflows from emerging markets. distressed state-owned companies in the energy The Western Balkan countries are vulnerable sector (Table 5.2). Yet, the space has been to these developments, particularly those greatly exhausted by the COVID-19 support countries with high debt burdens and limited that is being phased out. Some of the countries fiscal space. The S&P credit rating agency already adopted support packages in excess of has affirmed countries’ credit ratings and 4 percent of GDP, which would require budget stable outlooks, except for Serbia, where S&P rebalancing three months into the fiscal year. Table 5.1. Country credit ratings stayed mostly stable Moody’s Standard & Poor’s Fitch Albania B1 (stable) B+ (stable) — Bosnia and Herzegovina B3 (stable) B (stable) — Montenegro B1 (stable) B (stable) — North Macedonia — BB- (stable) BB+ (negative) Serbia Ba2 (stable) BB+ (positive) BB+ (stable) Note: — = not available. Table 5.2. Estimated government support for the energy and food crisis, percent of GDP ALB BIH KOS MKD MNE SRB State aid to energy company 1.1 0.0 1.3 1.4 0.0 0.8 Tax exemptions 0.0 0.0 0.0 1.5 0.0 0.9 Social benefits 0.3 0.1 0.4 0.2 0.1 0.8 Subsidies 0.0 0.5 0.3 1.9 0.1 0.0 Total 1.4 0.6 2.1 4.9 0.2 16 2.5 Sources: National authorities; World Bank staff calculations. Note: The estimated support does not include the proposed but not yet approved measures by national parliaments. The packages of support include measures adopted by March 25, 2022. 16 Montenegro plans additional spending of 0.6 percent of GDP for emergency procurement of key commodities, as it does not have strategic commodity reserves. 26  |  5. Continued need for fiscal support against limited space STEERING THROUGH CRISES The fiscal plans for 2022 initially targeted a modest increase in the fiscal deficit for the region of 0.5 pp in 2022, but the realism of such plans largely hinges on the persistence of the energy and inflationary impact from the war in Ukraine, including through pressures for higher fiscal support measures. To ensure their fiscal space does not erode, governments of the Western Balkan countries should consider widening the tax base and improving tax compliance. Most of the countries reduced the VAT and/or excises on energy and food to reduce price pressures, given the ongoing crisis. While those will need to be reverted, targeted social assistance would be recommended, as it targets the most vulnerable. Tax exemptions given to certain sectors and foreign direct investment firms need to be reconsidered in a given context whereby firms are nearshoring to Europe. Further, the Western Balkan countries should significantly strengthen their public financial management, reduce payment arrears that increased in several countries (North Macedonia, Albania), and manage contingent liabilities coming from state-owned enterprises and public-private partnerships (Albania, North Macedonia, Serbia). Most countries plan to increase public investments, but to achieve optimal growth- enhancing effects of such spending, the public investment management systems should be strengthened. This is particularly needed in terms of greening public investments that can crowd in significant private sector investments and ensure more sustainable and inclusive growth. 5. Continued need for fiscal support against limited space  |  27 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 6. Higher inflation presents policy challenges The rebound in global activity since mid- With the start of the war in Ukraine in 2020, continuing supply disruptions, and February 2022, inflationary pressures were rising food and energy prices, pushed amplified. With Russia and Ukraine as major headline inflation to decade highs across wheat exporters accounting jointly for one- many countries even before the war in quarter of the global supply, another wave Ukraine. After decades of low price growth, of food price increases has materialized. In inflation has returned, becoming a major addition, Russia is the world’s largest exporter of challenge for central banks across the world fertilizers, while Ukraine is the largest exporter (Figure 6.1). Global inflation, measured as of seed oil (38 percent of the world market) and the median headline consumer price inflation, the fourth-largest exporter of corn (11 percent rose to 4.6 percent in October 2021, from a of the world market). In response to the crisis, pandemic-related trough of 1.2 percent in May several countries in the region introduced grain 2020. Global food prices rose by 29.3 percent export bans, adding upward pressure to already (year on year) during 2021,17 disproportionally high prices. Meanwhile, the EU has imposed a affecting emerging market economies. ban on transactions with Russian state-owned Moreover, food prices exceeded 5 percent in enterprises, except in the oil and gas sector, 86 out of 109 (79 percent) emerging markets and select raw materials (such as aluminum, and developing economies (EMDEs).18 Food palladium, and copper), negatively affecting price inflation hits lower-income countries the global supply for a wide range of industries. particularly hard, as food accounts for a much larger share of the average household The war in Ukraine has especially impacted consumption basket. Besides food, energy and energy prices ( Figure 6.2). The Brent oil index other commodity price increases were strong increased by 28 percent between February during 2021. The 2021 annual average price of and March 2022. Russia is a major exporter crude oil was 12.5 percent higher than in 2019 of natural gas, and it also accounts for a large and—reflecting the pandemic downturn and share of global exports of coal, and crude rebound—67 percent higher than in 2020.19 oil. Europe relies particularly heavily on The oil and energy price increase drove up Russian imports to meet energy demand— production and transport costs across many the EU imported 45 percent of natural gas industries, leading to a general increase in and 27 percent of oil from Russia in 2021. price levels. Core consumer price inflation— While the oil and gas supply from Russia may typically excluding food and energy—also continue under sanction carve-outs, there are increased globally. risks that major gas transit routes through Ukraine may be disrupted, stricter financial sanctions on Russian banks may further disrupt 17 World Bank Global Economic Prospects, 2022. 18 Reinhart, von Luckner, 2022, https://blogs.worldbank.org/voices/return-global-inflation. 19 https://thedocs.worldbank.org/en/doc/5d903e848db1d1b83e0ec8f744e55570-0350012021/related/CMO-Pink-Sheet-March-2022.pdf 28  |  6. Higher inflation presents policy challenges STEERING THROUGH CRISES energy-related financial flows, or Russia may Inflation in the Western Balkan countries strategically halt the gas supply. Inventories of started picking up speed in the second half crude oil or natural gas to offset any disruption of 2021, predominantly through supply- would provide temporary relief, but there are side pressures ( Figure 6.3). At the same limited near-term prospects for additional time, strong consumer demand and higher pipeline gas imports and liquified natural gas passthrough effects also played a role. The terminal capacity. On March 8, the United headline consumer price index (CPI) growth in States introduced import bans on Russian oil January 2022 ranged from 8.2 percent in Serbia and gas, and the European Commission has to 3.7 percent in Albania. In all countries, proposed making Europe less dependent on food price inflation contributed the most to Russian fossil fuels. The uncertainty in the headline inflation: food and nonalcoholic energy market has already resulted in volatile beverages prices increased between 6.7 percent and rising prices. in Albania and 13.5 percent in Serbia (Figure Figure 6.1. Inflation picked up in 2021 in Figure 6.2. Energy prices soared at the start of most EMDEs the war in Ukraine Headline, core, food and energy inflation in EMDEs, percent Crude oil prices: Brent - Europe, dollars per barrel 20 140 130 15 120 10 110 5 100 90 0 80 -5 70 60 -10 22 2 22 n 2 Fe 22 b 2 Fe -22 Fe -22 M 22 M -22 2 -2 -2 2 -2 3- - - 7- - Ju 0 Ju 1 M 20 Se 0 No 20 Ja 0 M 21 Se 1 No 21 Ja 1 22 M 20 M 21 17 7 10 24 31 14 21 28 14 -2 l-2 2 -2 l-2 2 n- p- v- - n- b ar n- n p- v- - ay ar n ay b ar ar n n b Ja Ja Ja Ja Fe Ja Ja ▬ Headline ▬ Food ▬ Core ▬ Energy Sources: World Bank Global Economic Prospects 2022 Source: Federal Reserve Economic Data. Note: Figure shows median year-on-year food, headline, and core consumer price index (CPI) inflation for 50 EMDEs. Figure 6.3. Headline inflation in the WB6 Figure 6.4. Energy and food inflation drove this started picking up in the second half of 2021 increase y-o-y, percent 10 10 8 8 6 4 6 2 4 0 2 -2 -4 0 Ap 9 19 Oc 9 Ja 9 Ap 0 20 Oc 0 Ja 0 Ap 1 21 Oc 1 Ja 1 22 Ap 9 19 Oc 9 Ja 9 Ap 0 20 Oc 0 Ja 0 Ap 1 21 Oc 1 Ja 1 22 2 l-2 2 2 l-2 2 1 l-1 t-1 1 l-1 t-1 2 l-2 2 2 l-2 2 n- r- n- r- n- r- t- n- r- t- n- n- n- r- t- n- r- t- Ju Ju Ju Ju Ju Ju Ja Ja ▬ ALB ▬ BIH ▬ KOS ▬ MKD ▬ MNE ▬ SRB ▬ WB6 ▬ CPI inflation ▬ Energy CPI inflation ▬ Food CPI inflation Source: National statistical agencies. Source: National statistical agencies. 6. Higher inflation presents policy challenges  |  29 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 6.4). Higher energy prices also translated into wage, in some cases double-digit increase— higher transport prices across the region. partly in response to food and energy price increases. The increase in minimum wages Besides food and energy prices, core will exert further pressure on the recent overall inflation has increased in all countries of wage and inflation increase accompanying the the region. Core inflation reached a record recovery during 2021. high of 2.9 percent in December 2021, as persistent supply shocks and wage increases are To protect households against the sharp fueling inflation expectations. Since January increase in food and energy prices, 2022, inflationary pressures further intensified, governments in the WB6 countries have especially after the start of the war in Ukraine. taken action. The increase in inflation will Some WB6 countries are dependent on have an immediate impact on household Russia’s and Ukraine’s export of key food items welfare and poverty—particularly through including grains, vegetable oils and fertilizers, rising energy prices, which disproportionately while all WB6 countries are exposed to the hit the poor. Short-term measures include indirect impact of the global trade disruption selective price controls on some of the core food in key commodities, including energy. Rising items, electricity and fuel for motor vehicles gas prices are likely to affect the prices of all (Albania, Bosnia and Herzegovina, Kosovo, other energy sources, including electricity, North Macedonia, Serbia), imposing export which has already been under price pressure bans (North Macedonia, Serbia) and reducing due to insufficient production from renewable the VAT (Montenegro, North Macedonia). sources during 2021. Despite these measures, inflation is forecasted to average 6.3 percent in the region during Avoiding further pressures on firms through 2022 and to remain above historical averages rising labor and input costs will be important in 2023. to tame inflationary expectations. Countries in the region increased the statutory minimum Figure 6.5. Core inflation has increased in Figure 6.6. Inflationary expectations have most countries in the region started to materialize Core inflation in percent Expected inflation 12 months ahead, in percent 4 12 3 10 2 8 1 0 6 -1 4 -2 2 -3 -4 0 Ju 20 Ju 21 Ap 9 19 Oc 9 Ja 9 Ap 0 20 Oc 0 Ja 0 Ap 1 21 Oc 1 21 M -20 Se l-20 No -20 Ja -20 M -21 Se l-21 No -21 Ja -21 M -22 ay 0 M r-19 Ju 19 Se l-19 No -19 Ja -19 ay 1 2 2 l-2 M -2 -2 1 l-1 t-1 2 l-2 2 M r-2 n- r- - - n- r- t- - n- r- t- n ay p v p v ar n ar n p v Ju Ju a Ju a Ja M ▬ ALB ▬ BIH ▬ KOS ▬ MKD ▬ MNE ▬ SRB ▬ WB6 ▬ North Macedonia ▬ Serbia ▬ Albania Sources: Central banks. Sources: Central banks’ surveys from December 2021. Note: For Albania and Serbia the respondents are households; for North Macedonia, chambers and professional forecasters. 30  |  6. Higher inflation presents policy challenges STEERING THROUGH CRISES Monetary policy in the region started tightening in March 2022. In North Macedonia, the Central Bank increased the policy rate to 1.5 percent in April, while liquidity in the banking system stood high. In Serbia, the central bank sterilized excess liquidity from the banking sector through repo operations, but it increased the policy rate to 1.5 percent. In Albania, the Central Bank has started raising the policy rate earlier. The base interest rate was raised to 1 percent in March 2022. High inflation and rising inflationary expectations, normalization of monetary policy rates in advanced countries, and rising risk premia given the Ukraine crisis, have all pushed the central banks of Western Balkan countries toward future tightening of monetary policy. This will need to be weighed against the need to support the fragile recovery, given headwinds from the Ukraine crisis. In the countries with a flexible exchange rate regime, the national currencies of the WB6 countries were stable during 2021. Increased trading volumes in energy and food caused a short-lived depreciation in late February 2022 of the Serbian dinar and the Albanian lek against the euro and the dollar. In both countries, the official reserves are significant, covering 6 and 8.2 months of imports, respectively. 6. Higher inflation presents policy challenges  |  31 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 7. Financial stability continued to be preserved amid looming economic risks The financial system remained resilient during level vulnerabilities and strengthen supervision the post-COVID recovery; nevertheless, risks and enforcement of prudential requirements are tilted to the downside. Overall, in 2021, the to cope with the highly uncertain economic Western Balkans’ financial sector maintained outlook. adequate capital and liquidity buffers and avoided deterioration of its asset quality, while In addition to the post-COVID risks, which at the same time commercial banks managed have been monitored closely by regulators to increase profitability. This was due to the and policy makers, new economic risks COVID-19 financial support measures that are building up for the region. The new included borrower relief measures (that is, loan risks include a protracted pandemic shock, moratoriums and loan restructuring), and the the war in Ukraine, prolonged supply chain economic growth recovery in 2021 across the disruptions, inflationary pressures, tightening Western Balkans that helped minimize negative global liquidity, weak domestic political impacts on the financial sectors. stability, and the energy crisis. They have the potential to impact the financial sector directly Although a major deterioration of asset and indirectly through asset prices and macro- quality has been avoided so far, economies financial linkages, as well as potential spillovers remain fragile, and significant disparities to the financial sector from deteriorating persist in performance at the country, government, private sector, and household sector, and bank levels. The industries most balance sheets. Among the most recent impact negatively impacted by the short-term liquidity is the war in Ukraine and the effect of the shocks of the COVID-19 pandemic—the financial sanctions on Russia, which have food, accommodation, and entertainment had a direct impact on the Western Balkans. industries—may face pressures in 2022 as Specifically, Sberbank Europe AG, a fully the support measures begin to wind down owned subsidiary of Sberbank Russia, faced a and the economic recovery pace slows, which liquidity crisis, which impacted three Sberbank may increase their vulnerability to any further subsidiaries – one in Serbia and two in Bosnia shocks.20 According to the results of the and Herzegovina. All three subsidiaries were Central, Eastern and South-Eastern Europe rapidly taken over by other local banking (CESEE) Bank Lending Survey,21 banks in groups, thereby containing further negative the region do not expect the improvement in financial sector impacts. nonperforming loans (NPLs) to continue over the next six months, signaling a still elevated Other risks faced by the region’s financial level of uncertainty. Going forward, financial sector are transmission mechanisms sector regulators need to continue to closely operating through the regional/European monitor asset quality challenges and bank- banking groups active in the Western 20 NPL monitor for the CESEE region, Vienna Initiative, 2021 H2. 21 The CESEE Bank Lending Survey - Autumn 2021. 32  |  7. Financial stability continued to be preserved amid looming economic risks STEERING THROUGH CRISES Balkans, which are significantly exposed the tightening of global financial conditions; to Russia and Ukraine through loans and the impact of sanctions will be in the focus and equity. Such exposure could trigger a of central banks in the near future. The impact deleveraging of these groups or at least avoid of these developments on asset prices and their a further expansion of their current businesses macro-financial linkages will need to be closely in the Western Balkan region, while also monitored. slowing the region’s integration into the EU financial system. The CESEE bank lending Credit growth has been positive in all Western survey indicates that currently banking Balkan countries, with household loans group strategies are tilted toward selective growing faster than corporate loans ( Figure expansion in the region, and their medium- 7.1). After bottoming out in March 2021, term assessment of market potential and average loan growth in the region has been positioning showed no significant deterioration increasing continuously. As of December 2021, in 2021. However, as of March 2022, the the strongest credit growth has been registered continuing war in Ukraine and the potential in Kosovo (15.5 percent, y/y), followed by for further sanctions add to the uncertainty Serbia (8.8 percent, y/y). Demand for loans and may change the outlook. Mitigating is strong in Kosovo across all segments while factors include that most of the subsidiaries in in Serbia loan growth is driven by households the region are mainly funded by local deposits and corporate sector equally. In contrast, with less reliance on parent companies, which credit growth has been weak in Montenegro partly reduces an abrupt deleveraging risk. In (3.2 percent, y/y) and Bosnia and Herzegovina addition, these subsidiaries are commonly the (3.9 percent, y/y), driven by milder market most competitive banks operating in the region outlooks, expiration or tightening of support without major financial stability vulnerabilities programs, tighter loan supply conditions, and a such as undercapitalization, exposure to high generally volatile political environment fueling foreign exchange or liquidity risks, or asset uncertainty. In all countries credit growth has quality challenges. Rising inflationary pressures been accelerating in the second half of 2021, driven by food, commodity, and energy prices; except in Montenegro, where credit growth is Figure 7.1. Credit growth has been positive in Figure 7.2. Lending to households continued all countries and is accelerating to drive credit growth Change in nonfinancial private sector credit outstanding, Change in credit outstanding, December 2021, percent, y/y December 2021, percent, y/y 16 20 18 12 16 14 8 12 10 4 8 6 0 4 -4 2 Ju 16 No -16 Ap 16 Se 17 Fe 17 Ju 8 De 8 M -18 Oc 19 M -19 Au 20 Ja 0 Ju 21 No -21 21 0 1 l-1 2 r- p- - n- v- n- v- b- g- - ay t n c n ar 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. 7. Financial stability continued to be preserved amid looming economic risks  |  33 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 below the June 2021 level. On average in the region throughout the COVID crisis, driven by region, household loans grew by 9.5 percent, a stronger decline in the retail segment. surpassing corporate loan growth at 7.1 percent, a trend that has continued since July 2020 The borrower relief measures expired by the (Figure 7.2). end of 2021, except for the reintroduced targeted loan moratorium in Montenegro While there are variations at the country and extended measures in Bosnia and level, local and subsidiary banks in the Herzegovina until March 2022. These relief region reported a robust increase in demand measures include moratoriums, relaxation of for credit across the board, and somewhat loan classification standards for NPLs, and easing supply conditions since 2021 Q1. favorable loan restructuring schemes. As the Loan demand was supported by working capital benefits of these measures begin to fade, asset needs, positive housing market prospects, and quality challenges may surface with a lag in consumer confidence, while contributions 2022. The CESEE Bank Lending Survey from investments had turned positive again. indicates a reversal of the improvement in Supply conditions eased substantially for asset quality in the first half of 2022.23 These household segments, while they remained expectations are supported by some signs of tight for companies, particularly for small and vulnerabilities such as elevated stage 2 loans, medium-sized enterprises. In addition, easing vulnerable sectors (food, accommodations, supply trends manifested primarily for short- and entertainment), and a continued rise in term credit extensions. Banking groups’ global property values in some regions, building fears access to funding continued to ease over the of value readjustments to come. The NPL last six months and supported ease of supply Monitor (2021 H2), published by the Vienna conditions.22 Initiative, highlighted the surge of stage 2 loans due to COVID-19 in 2020. The study presents As of December 2021, the average NPL ratio a bank-level analysis conducted with a sample in the region slightly decreased compared to of the five largest banks by total assets in each its June 2021 value at 4.7 percent (Figure 7.3). of the Vienna Initiative partner countries24 and The regional average of 4.5 percent is slightly shows that stage 2 loan volumes increased in below the 5 percent threshold the European 18 of 25 banks, both from December 2018 to Banking Authority defines as a high NPL ratio; December 2019 and from December 2019 to nevertheless, NPL ratios are still higher than the December 2020.25 region’s average in Montenegro (6.8 percent), Bosnia and Herzegovina (5.8 percent), and Capital buffers in the Western Balkan Albania (5.7 percent). NPLs are increasing only countries remained broadly stable, while in Montenegro compared to its December 2020 bank liquidity is at its highest level since level. Kosovo’s NPLs remained the lowest in the December 2019. As of December 2021, bank capital adequacy averaged 18.2 percent, 22 The CESEE Bank Lending Survey - Autumn 2021. 23 The CESEE Bank Lending Survey - Autumn 2021. 24 Vienna Initiative partner countries are Albania, Croatia, Hungary, Montenegro, and Serbia. 25 NPL monitor for the CESEE region, Vienna Initiative, 2021 H2. 34  |  7. Financial stability continued to be preserved amid looming economic risks STEERING THROUGH CRISES Figure 7.3. NPLs are consistently decreasing Figure 7.4. Banks capital buffers preserved in Albania and Bosnia and Herzegovina while increasing in Montenegro NPLs as percent of total loans, December 2021 Capital adequacy ratio, percent, December 2021 9 25 8 7 20 6 15 5 4 10 3 2 5 1 0 0 MNE BIH ALB SRB MKD KOS SRB BIH MNE ALB MKD KOS J Dec-19 J Dec-20 J Dec-21 Q Pre-crisis level (end 2007) J Dec-19 J Dec-20 J Dec-21 Q Average (2006–08) Sources: IMF Financial Soundness Indicators; central banks. Sources: IMF Financial Soundness Indicators; central banks. far above the regulatory minimum, and lower will be important to monitor profitability, compared to December 2020, at 18.6 percent considering the risks for the outlook. If asset (Figure 7.4). The ratio of liquid to total assets quality deteriorates in 2022, this would put averaged 29.9 percent, slightly higher than in additional pressures on profitability, with December 2020 (29.1 percent). The loan-to- increasing impairment costs, and would reverse deposit ratios were well below 100 across the the recovery. board (75.9 percent on average in December 2021) and declining, indicating a faster deposit Going forward, authorities need to keep growth compared to loan growth. their focus on monitoring credit risks and the evolution of distressed loans, as well Regional average bank profitability as the potential spillovers from the risks continued its recovery, approaching its related to the sanctions on Russia and the December 2019 value as of December 2021. war in Ukraine. It is equally important for the Profitability as measured by return on assets authorities to refocus on a medium- to long- has increased to 1.4 percent in December 2021 term reform agenda to align financial systems from 1.1 percent in December 2020, mainly in the region with international standards (that due to expiring borrower relief measures, is, Basel Core Principles, European Union increasing loan growth, removal of additional Banking Directives) that might have been provisioning, and declining impairment costs. interrupted due to the pressing priority of the As of December 2021, Kosovo has the highest COVID-19 response. Within this framework, profitability (2.3 percent) while Montenegro reforms related to greening the financial sector has the lowest (0.8 percent). The CESEE Bank are emerging as a top priority especially for Lending Survey also confirms this outcome, the Western Balkan countries that are aiming showing that all the international banks to achieve alignment with the EU. A growing operating in Kosovo reported higher return number of central banks and regulators have on assets compared to their group profitability, issued warnings on the impact of climate and while in Serbia this ratio is 40 percent. It environmental risks on the stability of their 7. Financial stability continued to be preserved amid looming economic risks  |  35 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 financial systems, resulting from both physical banks in the region to ensure that the financial and transition risks. At the same time, there sector has the capacity to cope with the climate is a global recognition of the emerging role of change risks and that they are equipped with the financial sector in mobilizing capital for the instruments for green investment financing green objectives. Greening the financial sector (Box 7.1). will be essential for the regulators and central Box 7.1. Greening the financial sector in the Western Balkans The financial sector and firms are exposed to both physical and transition risks due to the impact of climate change. Physical risks stem from both the gradual and abrupt impacts of climate change and natural disasters – such as droughts, floods, and hurricanes—on the value of real assets and their underlying financial instruments. Transition risks originate from efforts to mitigate climate change and improve local environmental conditions by decarbonizing the economy, which may create economic adjustment costs in a broad range of sectors. These costs can create financial risks for firms and investors that did not anticipate the transition and ultimately jeopardize the functioning and stability of the financial system. At the same time, the financial sector’s role in developing new and long-term financing instruments and mobilizing private capital for green investment is equally important when considering the unprecedented financing needs. The investment and financing needs exceed the capacity of any public resources or national budgets and would require massive private financing for sustainable investments. The Western Balkan (WB) countries are exposed to a number of physical and transition risks, while the financial sector is underprepared to manage these risks. Collectively, across the six countries (WB6), the high to medium climate risks are floods, landslides, wildfire, earthquakes, landslides, extreme heat, and water scarcity. Furthermore, the WB6 countries are one of the European hotspots of environmental pollution and have very poor air quality, with elevated levels of particulate matter (PM), especially fine particles. According to a study published by Europe Beyond Coal using data from the European Coal Plant Database (2019), the 16 coal-fired power plants in the WB6 produced on average 20 times the amount of sulfur dioxide and 16 times the amount of PM emissions as the average EU coal plant.26 Consequently, the WB6 have some of the most polluted cities in Europe. A recent report by the European Commission has apportioned air pollution in the 13 largest WB6 cities. In addition to air pollution, these countries are at the low end of resource productivity, with values of 0.35 euro per kilogram, much lower than the EU average of 2.07 euros per kilogram, according to Eurostat. The recycling of waste is low—below 3 percent, compared to the 44 percent EU average. While exposed to above-mentioned physical and transition risks, all six countries are also signatories to the Paris Agreement and thus are obligated to take action to keep temperature increases below 2.0 degrees Celsius, and even aim to achieve global warming of no more than 1.5 degrees. Financial markets in the Western Balkans are not deep and diversified enough to provide a sufficient variety of financial instruments and mobilize private capital for financing green investments. The investment and financing needed to economically transition to a green economy exceed the capacity of public resources or national budgets and would require substantive private financing for sustainable investments. However, the depth of the financial sector in WB6 economies 26 The goal of Europe Beyond Coal, which was established in 2017, is to ensure that coal is phased out throughout Europe by 2030. 36  |  7. Financial stability continued to be preserved amid looming economic risks STEERING THROUGH CRISES Box 7.1 continued as measured by private sector credit to GDP stands at an average of 45 percent– significantly lower than the ECA average of 87 percent – with particularly low levels in Albania, Kosovo, and Serbia. Commercial banks, which dominate financial sectors, recently increased their funding of energy efficiency and renewable energy projects. However, green loan portfolios are not well measured and are still small. Only Serbia has issued a green bond in the region—in September 2021, for EUR 1 billion. To manage financial risks stemming from climate change and to reorient capital flows toward sustainable and green investments, WB6 countries need to embark on a number of regulatory reforms and capacity building. Regulators and central banks should make sure that financial sector (banking, insurance, and capital markets) regulatory and supervisory frameworks and risk management capacities are developed to properly identify, measure, monitor, and manage climate-related risks. Taxonomies should be developed to establish a classification system for sustainable activities and to create standards and labels for green financial products. Disclosure and accounting regulations should be adopted and strengthened to reflect sustainability and climate risks. Financial institution’s governance and strategy frameworks should incorporate climate change considerations, with increasing board and senior management responsibilities and awareness. New financial instruments should be developed to stimulate long-term investments in green and sustainable projects, such as green bonds, securitizations, banking products (that is, guarantees), strategic investment funds, and green mortgages. Financial sector standard-setting bodies27 and the European Green Deal (EGD) framework provide necessary guidance to WB6 countries on how to strengthen the regulatory and enabling environment for greening the financial sector. The European Green Deal, launched in December 2019, provides a relevant framework for WB6 countries, as their ultimate goal is to join the EU. Transforming the financial sector and building capacity for managing climate-related risks and mobilizing capital for green development are integral elements of the Green Deal and EU sustainable finance framework. The EU introduced the Renewed Sustainable Finance Strategy to reform the financial sector and make it a key part of the solution toward a greener and more sustainable economy. The EU also introduced sustainable reporting standards, a green taxonomy, green bond standards, and stress test methodologies through the ECB as important enablers of greening the financial sector. Large-scale international collaboration and guidance are also available through the Network for Greening the Financial System, Task Force on Climate-related Financial Disclosures and financial sector standard setters. The WB6 countries have begun preparatory efforts for greening their financial sectors. Serbia issued the first sovereign green bond in 2021 and adopted a green bond framework. Beyond this, financial instruments targeting energy efficiency and renewable energy investments are getting widespread in the region. The World Bank initiated green finance diagnostics to help WB6 countries identify challenges and opportunities and prepare their strategy along with actionable roadmaps for greening their financial sectors. Pilot diagnostics are currently taking place in Serbia and Albania. In addition, the World Bank’s Financial Sector Advisory Center (FinSAC) has introduced a program to support regulators and central banks in the region to strengthen risk management capacities for climate-related risks. 27 Bank for International Settlements (BIS), Basel Committee on Banking Supervision (BCBS), Financial Stability Board (FSB), International Association of Insurance Supervisors (IAIS), International Organization of Pension Supervisors (IOPS), International Organization of Securities Commissions (IOSCO). 7. Financial stability continued to be preserved amid looming economic risks  |  37 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the Western Balkans The global economic effects of the war in Macedonia maintained a broadly unchanged Ukraine, and associated sanctions on Russia, CAD of 3.5 percent of GDP, despite a have significantly disrupted a strong but rebound in real private consumption growth short-lived post-pandemic recovery in the to 5.9 percent and an increase in both public Western Balkans. The strength of the post- and private investment. Serbia and Kosovo COVID rebound across the Western Balkans are the only two countries in the region that exceeded expectations. Yet, this speedy recovery widened their external deficits, despite an was short-lived due to the external shock of the outstanding merchandise export performance. Ukraine war propagating through the external In Kosovo, the worsening of the external sector. The global economic fallout from the war imbalance was more substantial than in Serbia in Ukraine disrupted commodity and energy and is testament to the large import content trade and further increased commodity prices. of exports. The imbalance in Kosovo was It also aggravated already significant inflation supported, among others, by the sharp increase pressures caused by the COVID-19 pandemic, in private consumption fueled by strong disrupted financial and tourism flows, and in credit growth amounting above 10 percent, in general exacerbated consumer and investor nominal terms. In response, the CAD expanded uncertainties (Table 8.1.). The effects of these from 7 percent in 2020 to 9.1 percent of GDP disruptions could be amplified by countries’ in 2021. In Serbia, the external imbalance protectionist measures, such as the export bans widened marginally, by 0.3 percentage points on wheat announced by Hungary and Serbia, compared to the year before, to 4.4 percent of key regional suppliers. GDP. In 2021, the current account deficit (CAD) The value of merchandise trade28 in the narrowed in most countries in the region. Western Balkans soared about 30 percent As expected, the largest decline in external in 2021, after the pandemic-induced imbalances occurred in Montenegro, which contraction in 2020. The strong rebound recovered from the COVID-19-induced reflected an increase of 39 percent year on year tourism crisis in 2020. The CAD narrowed in exports, and a strong jump in imports of by 17 percentage points to 9.2 percent of 29 percent year on year. In all countries but GDP (Figure 8.1). Similarly, the external North Macedonia, exports outpaced imports, deficit narrowed in Albania and Bosnia and yet across the board, merchandise trade deficits Herzegovina by 0.9 and 1.6 percentage points deteriorated to pre-crisis levels, and even of GDP, respectively, although at significantly exceeded them, in GDP terms, due to a larger different levels—in Albania, the CAD totaled import base. The exceptions are Bosnia and 7.7 percent in 2021, and in Bosnia and Herzegovina, Montenegro and Serbia, with Herzegovina, 2.3 percent of GDP. North merchandise trade deficits of 1 to 3 percentage 28 Exports and imports of goods from the trade statistics. 38  |  8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the WB STEERING THROUGH CRISES points lower compared to 2019, or close to of base metals and rubber and plastic products 20 percent in Bosnia and Herzegovina and rose 59 and 24 percent, respectively, while the 40 percent of GDP in Montenegro. Serbia export of electrical equipment increased nearly exhibited the lowest merchandise trade deficits 25 percent. The hike in the export of these in the Western Balkans in 2021 (11 percent of products offset the slowdown in trade of car GDP). supply chain firms due to supply disruptions and lower demand from EU car manufacturers. Exports to Germany, Italy, Croatia, Slovenia, Such developments were also observed in North and Greece, but also within-region trading, Macedonia’s suppliers of car manufacturers. accounted for most of the rapid deepening Serbian exports to Germany, Italy and Bosnia of exports in 2021. Albania’s rapid growth and Herzegovina grew between 25 and in exports to Spain, Kosovo, and Greece was 29 percent, while exports to Hungary recorded mainly in minerals, fuel, and electricity, whereas a growth rate of 35 percent. Serbia’s exports are textile and footwear as well as construction spatially more diversified compared to the rest materials and metals were exported to Italy. In of the Western Balkans, with these four markets Bosnia and Herzegovina, meanwhile, exports accounting for one-third of all exports. of mineral fuels rose 71 percent and furniture 22 percent, with the rise in aluminum product Net services and remittances largely returned exports reaching 159 percent, and wood to pre-pandemic levels, helping narrow the products totaling 36 percent compared to the external deficits. Net services were an important year before. Kosovo’s merchandise exports source of net inflows that in part offset the doubled to Italy and North Macedonia and structurally high merchandise trade deficits in rose 40 percent to Switzerland and Germany the region, which range from 11 percent of in 2021. This spike was the result of exports of GDP in Serbia to 47 percent of GDP in Kosovo. plastic products and base metals, which grew In Albania, Kosovo and North Macedonia, 40 percent and account for close to half of total net services, in GDP terms, exceeded pre- merchandise exports. Finally, Serbia’s exports pandemic levels by as much as 1 percent of Figure 8.1. Current account deficits (CAD) Figure 8.2. …and were mostly met by narrowed in most countries in the region… recovering FDI. Contributions, 2021 preliminary, percent of GDP 2021 preliminary, percent of GDP 20 12 15 10 10 8 5 0 6 -5 4 -10 2 -15 -20 0 MNE BIH ALB MKD SRB KOS MNE KOS ALB SRB MKD BIH WB6 J Goods exports J Goods imports J Net services exports J Remittances J CAD J Net FDI J Others Q Change in CA deficit Sources: Central banks; World Bank staff estimates. Sources: Central banks; World Bank staff estimates. 8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the WB  |  39 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 GDP. In Kosovo and North Macedonia, visits recorded in 2020, roughly at 3.5 percent of by workers living abroad account for the GDP. Instead, intercompany loans accelerated majority of travel inflows, whereas Albania has and more than doubled during the past two a more prominent tourism sector. Together years compared to the pre-pandemic period. with net services, remittances also exceeded pre-pandemic levels, relative to GDP, except Strong financial net inflows resulted in a in Albania, Bosnia and Herzegovina, and sizable buildup of foreign exchange reserves. Serbia. Overall, across the region, net inflows By end-2021, foreign exchange reserves were of services and remittances in 2021 offset two- strengthened across the region, except in thirds of the merchandise trade deficit. North Montenegro, where they remained constant Macedonia, with traditionally much lower due to net debt repayments by the government, levels of net service and remittances inflows, is banks, and the private corporate sector. Overall, the exception, with this coverage totaling only foreign exchange reserves exceed the metric of 35 percent in 2021. internationally prudent adequacy levels for all countries. Nominal exchange rates remained The external imbalances were largely funded stable in Serbia and North Macedonia by non-debt-creating flows. Net foreign throughout 2021 and appreciated slightly in direct investment (FDI) in the form of equity Albania. This trend continued in early 2022 and reinvested earnings drove the financing before the outbreak of war in Ukraine. of the external shortfalls in the region (Figure 8.2). In Albania, Bosnia and Herzegovina, and The energy shock and accompanying terms Montenegro, this was especially pronounced, of trade deterioration are likely to widen the with equity and reinvested earnings totaling current account deficit across the Western 7 percent of GDP, 5.8 percent of GDP,29 and Balkans in 2022. Russia is a major supplier of 8.1 percent of GDP, respectively, as investment natural gas and oil, and Ukraine is one of the in retail trade, financial services, the metal main transit routes. If oil prices remain above industry (Bosnia and Herzegovina) and US$95 per barrel, together with other global tourism (Montenegro) represented a multiple commodity price increases, this will raise the oil of net FDI in 2019. In Albania, net equity and import bill, among others, and widen the already reinvested earnings from FDI financing closed structurally large merchandise trade deficits 80 percent of the external imbalance, and offset across the region. The impact of a slowdown large portfolio outflows in 2021. The latter was in the EU could also affect car manufacturing driven by a sizable increase in foreign exchange exports in the Western Balkans, and dampen deposits, which banks invested abroad in remittances and services exports from the bonds. In North Macedonia, meanwhile, non- EU, on top of the reduction in tourists from debt creating FDI inflows remained below pre- Russia in Ukraine, which are important source pandemic levels, but were accompanied in 2021 markets for two Western Balkan countries. by a sizable inflow of intercompany loans. In Nevertheless, sizable foreign exchange reserves Serbia, net FDI equity and reinvested earnings in the region built up in recent years provide did not pick up in 2021 and remained at levels a viable shock absorber. In other countries, 29 For the first three quarters of 2021. 40  |  8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the WB STEERING THROUGH CRISES with either unilateral euroization or currency While a disruption of natural gas supply looks boards, the adjustment will take place through remote at this stage, barring future sanctions in the real sector. the form of import restrictions by the West or export controls by Russia, natural gas prices may Risks from direct trade linkages with Russia, soar going forward on top of the 400 percent Ukraine, and Belarus show a mixed picture increase in 2021, affecting households and in the Western Balkans  (Table 8.1). Unlike industry in the region. Spillover effects will be the Middle East and North Africa, imports most acute for electricity production, heating, of agricultural commodities, especially wheat, and the steel, iron, and aluminum industries, do not represent a major risk for the Western to mention a few. Finally, Albania imports one- Balkans, except in Albania, which imports tenth of its total oil imports from Russia, and 50 percent of its wheat from Russia and Serbia imports one-third, with risks of supply Ukraine. That said, an agreement between disruptions. It is also unclear how western Albania and Serbia may have in part alleviated sanctions will impact operationally the national potential supply shortages. Considering the oil company in Serbia, with Gazprom as the limits in expanding production worldwide, the majority owner. The oil company’s annual dislocation in the trade of wheat accounts for revenues are about EUR 2 billion, of which 60 to 70 percent spike in its price from early nearly EUR 500 million are export earnings, 2022 until March. Furthermore, Russia is the which could be affected by the sanctions. main supplier of natural gas to the region. Table 8.1. Heatmap of select transmission channels to Western Balkan countries Natural gas import dependencya Natural gas imports from Russiab Exportsc Importsd Russian inbound FDI, stocke Wheat imports from Russia Wheat imports from Ukraine Bankingf Tourismg Remittances from Russia Nitrogeneous fertilizer Potassium fertilizer Albania Bosnia and Herzegovina North Macedonia Montenegro Serbia Kosovo 75+ 75+ 20+ 20+ 15+ 75+ 10+ 3+ 3+ 10+ 60+ 60+ 50–75 50–75 10–20 10–20 5–15 50–75 5–10 2–3 2–3 5–10 40–60 41–60 25–50 25–50 5–10 5–10 2–5 25–50 2–5 1–2 1–2 2–5 20–40 21–40 0–25 0–25 0–5 0–5 0–2 0–25 0–2 0–1 0–1 0–2 0–20 0–21 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Note: (a) Energy import dependency is the share of energy needs met by imports, calculated from energy balances as net imports divided by the gross available energy (Eurostat); (b) Share of natural gas imports from Russia in total natural gas imports (c,d) Exports to and imports from Russia as percent of trading partners’ GDP (COMTRADE); (d) FDI stock from Russia as percent of recipient country’s total (CDIS); (f) Bank claims to Russia are percent of consolidated positions, including risk transfers and commitments, of creditor country’s GDP (BIS); (g) Share of international tourism receipts adjusted for the share of Russian and Ukrainian tourist arrivals in total foreign tourists arrivals, as share of GDP. 8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the WB  |  41 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 With sanctions impeding air transport from The indirect impact on trade involves a terms- Russia, direct trade in services could have of-trade shock and reduced exports to Russia a sizable impact on several countries in the by EU trading partners. Machinery and region. In Montenegro, service exports to vehicles account for about a quarter of Russian Russia, Ukraine, and Belarus totaled EUR350 imports, and countries that supply components million, or 7 percent of GDP in 2019. used in the production of these goods will Specifically, Russian tourists accounted for a suffer a further contraction in exports. In quarter of total overnight stays during 2017 to addition, supply-chain disruptions associated 2020. In 2021, in the absence of direct flights, with exports from Russia and Ukraine are likely Russian tourists still accounted for 12 percent to cause production frictions in European of total overnight stays. In addition, Ukrainian manufacturing exacerbating adverse demand tourists constituted almost 10 percent of total effects for suppliers in the Western Balkans. In overnight stays in 2021. In Serbia, meanwhile, North Macedonia and Bosnia and Herzegovina, revenues from Russian and Ukrainian tourists the adverse impact on the textile supply chain amounted to about EUR140 million annually, and car manufacturing, respectively, will affect or 10 percent of total tourism revenues. The lack exports. At the same time, however, iron, steel of tourist inflows from these two source markets and aluminum producers across the region could further aggravate Serbia’s merchandise might benefit from trade diversion. export exposure to the Russian market, which totals roughly 5 percent of total exports. At the same time, it could also benefit from trade diversion as it has not joined the EU-imposed sanctions. Ukraine is the second largest source country of tourists visiting Albania through charter flights and accounts for 30 percent of tourism exports. The direct financial channel exposure to the war in Ukraine is limited, while indirect spillover effects from exposures by parent companies are unclear. Authorities in Bosnia and Herzegovina and Serbia acted promptly and sold subsidiaries of Sberbank shortly after the outbreak of war in Ukraine. Other banks with Russian or Ukrainian capital in the region are small in market size. Indirect effects stemming from exposures from European parent companies to Russia are uncertain and are being monitored carefully. 42  |  8. The new crisis has cut short the better-than-expected post-pandemic trade recovery in the WB STEERING THROUGH CRISES 9. The post-pandemic rebound is cut short The outlook for Western Balkan countries into and demand from the Western Balkans. has changed significantly since the start As a result, projected GDP growth for 2022 of the war in Ukraine. After a better-than- has been cut by almost one percentage point, expected recovery in 2021, a relatively robust in line with revisions to growth for major growth path was expected to persist in 2022 economies (Figure 9.1). and beyond. GDP growth for the Western Balkans was expected to be 4.1 percent in Increased international prices of food, 2022 and 3.8 percent in 2023. However, the oil, and metals started hurting the global outbreak of war in Ukraine has cut short the recovery and growth in the Western Balkans, post-pandemic rebound, and growth for 2022 even before the war started. Food prices (as has now been revised downward by almost one measured by the United Nations Food and percentage point to 3.1 percent in 2022. Agriculture Organization Food Price Index) increased by 5.3 points, to an average of There are several channels of impact from 140.7 points in February 2022, 24.1 points the war in Ukraine on the economies of the above its level a year ago. This represents a Western Balkans. Among these, it is certain new all-time high, exceeding the previous peak that inflation will be even higher, because of in February 2011 by 3.1 points (Figure 9.2). additional increases in food and energy prices, Similarly, international metals and minerals and that lower exports, disruptions in supply prices have reached historically high levels in chains, and lower tourism revenues would also recent months. The World Bank composite likely lead to a slowdown in growth. A broader index of metals and minerals was 32.3 percent shock to business confidence across Europe higher in February 2022 compared to a would also have implications for investments year ago. Prices of aluminum, tin, zinc, and Figure 9.1. Growth projections were revised Figure 9.2. Food prices reached an all-time downward high, as did metals and minerals, while oil prices increased sharply, too Revisions to GDP forecast, in pp 2010=100 0 160 140 -0.5 120 100 -1.0 80 -1.5 60 40 -2.0 20 0 10 Ja 1 12 Ja 3 14 Ja 5 16 Ja 7 18 Ja 9 Ja 0 Ja 1 22 -2.5 1 2 1 1 1 1 2 n- n- n- n- n- n- n- n- n- n- n- n- n- Ja BIH KOS ALB MKD SRB MNE Ja Ja Ja Ja Ja ▬ Food price index ▬ Metals and minerals ▬ Crude oil Source: World Bank staff calculations. Sources: UN Food and Agriculture Organization; World Bank. 9. The post-pandemic rebound is cut short  |  43 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 nickel increased most by February 2022. The COVID-19 cases approaching or surpassing significant increase in commodity prices, previous peaks. Vaccination rates appear to including metals, was due to a stronger-than- have plateaued and continue to lag the world expected recovery in growth across the world, average of 57 percent, and clearly lag the EU especially in advanced economies, as a result of average of 73 percent (Figure 9.3). fiscal stimulus and pent-up demand. Finally, oil prices have increased significantly recently. Figure 9.3. Vaccination rates have stagnated After reaching a bottom in April 2020, crude well below EU rates oil prices increased by 344 percent (that is, Share of population, percent 80 from US$21.0 per barrel to US$93.5 per barrel 70 73 in February 2022). 60 48 50 45 46 The impact of the Ukraine war will be 42 40 40 significant across the region because of the 30 26 expected increase in commodity and energy 20 prices, but some countries will be hit more 10 than others since channels of transmission 0 BIH MKD ALB MNE KOS SRB EU differ from country to country. Higher Source: https://ourworldindata.org/covid-vaccination-dataset, accessed commodity prices and availability, particularly March 24, 2022. Note: Total number of people who received vaccine dose per initial protocol metals and grains, as well as higher energy divided by the total population of the country. prices, are expected to be the main transmission channel common to all countries in the region.30 Inflationary pressures are expected to Direct trade, remittances, and investment increase as the conflict in Ukraine causes a linkages are low for Albania, Bosnia and further increase in food and energy prices. Herzegovina, Kosovo, and North Macedonia, As the economies have recovered faster, but are more important for Montenegro and inflationary pressures started to build up in the Serbia. The main direct transmission channel second half of 2021. Average inflation in the to Montenegro’s economy is tourism. In 2021, region was 3.3 percent in 2021, compared to tourists from Russia, Ukraine, and Belarus 0.9 percent in 2020. Energy price adjustments accounted for 22 percent of total overnight will push inflation up further when price stays. In the case of Serbia, the main channels are controls effective since the last quarter of 2021 exports, foreign direct investment, remittances, are lifted. Therefore, inflation is projected to and tourism, since Russia and Ukraine account reach 6.3 percent in 2022. for 5 percent, 6.5 percent, 3 percent, and 10 percent of the total, respectively. Fiscal deficits are expected to widen as both revenues and expenditures will be affected by COVID remains a concern. Western Balkans international developments. After a significant countries were among those most impacted reduction in deficits across the region in 2021, by the spread of the Delta variant in the third from 7.3 to 3.3 percent of GDP, on average, quarter of 2021, with the number of new they will expand again in 2022. Governments 30 Russia is the world’s largest exporter of oil to global markets and the second-largest crude oil exporter behind Saudi Arabia. In addition, Ukraine and Russia account for about 30 percent of the world’s traded wheat. 44  |  9. The post-pandemic rebound is cut short STEERING THROUGH CRISES will need to provide additional support to The outlook for the Western Balkans is households and the economy to tackle the subject to a series of risks, mostly tilted to the ongoing energy and broader economic crises downside ( Box 9.1). A prolonged pandemic caused by the war in Ukraine. To create the and the rise of new variants domestically and fiscal space, some governments might opt for internationally could adversely affect growth delays in starting new or completing existing and confidence. The war in Ukraine could infrastructure projects, which will further slow bring further disruptions in global trade, which growth.31 Revenues will also be affected by the in turn may weaken domestic production and economic slowdown.32 Public and publicly the export of goods and services. In the absence guaranteed debt is expected to start to gradually of fiscal consolidation, especially for countries decline, from 56.5 percent in 2021 to 55.7 in with high debt, like Albania, Montenegro, 2022, and to decline further over the medium and North Macedonia, refinancing risks could term. arise if external financial market conditions tighten. Debt sustainability may become a With increased energy, food, and raw material concern, while access to finance may become prices, external deficits are also expected more expensive as monetary tightening to widen. On average, the merchandise trade accelerates due to higher inflation in advanced deficit will increase from 19.4 to 20.6 percent economies.33 The risks of political polarization of GDP. In addition, it is expected that also remain high. In Bosnia and Herzegovina, remittances will fall, as will revenues from some the current political deadlock could be further services, tourism in particular. This in turn will amplified in the pre-election period, adversely lead to an increasing current account deficit affecting implementation of the adopted (CAD). The CAD will on average increase socioeconomic program needed to address the from 4.9 to 6.3 percent of GDP. Consequently, country’s development challenges and pave the external debt will increase significantly in 2022 way for EU accession. to reach a new historical high of 92 percent of GDP. 31 On the positive side, on February 25, 2022, the European Commission unveiled a €3.2 billion investment package to support 21 transport, digital, climate, and energy connectivity projects in the Western Balkans. This is the first major package of projects under the EU’s Economic and Investment Plan for the Western Balkans, which the European Commission adopted in October 2020. 32 Although higher inflation will help to increase some revenues, at least in minimal terms. 33 On March 11, 2022, the U.S. Fed executed its final quantitative easing (QE) purchase, after adding more than US$5 trillion of securities since the COVID-19 pandemic began. This was nearly 50 percent more than the amount added through three rounds of QE between 2009 and 2014 to combat the global financial crisis. 9. The post-pandemic rebound is cut short  |  45 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Box 9.1. Global economic recovery faces severe headwinds from war in Ukraine and COVID-19 pandemic The global economic recovery was already decelerating prior to the Russian Federation’s war with Ukraine, because of COVID-19 disruptions, diminished policy support, and lingering supply chain bottlenecks. Global growth was on track to ease from an estimated 5.5 percent in 2021 to 4.1 percent in 202234 the sharpest global slowdown in a post-recession recovery since at least the 1970s. The exceptional slowdown in growth anticipated before the war left the global economy vulnerable to adverse shocks, especially in emerging market and developing economies (EMDEs), where recoveries were already notably weaker and more fragile than those in advanced economies. The war in Ukraine, however, has cast a further shadow over global growth prospects. The effects of Russia’s invasion of Ukraine have rippled through multiple global channels, including commodity and financial markets, trade and migration links, and confidence. Since late January, private sector forecasts for global growth in 2022 have been revised downward by [0.5] percentage points and are likely to continue to fall as forecasters fully incorporate the war into projections. OECD model-based estimates suggest that global growth could be around 1 percentage point lower this year, placing global growth closer to 3 percent.35 Moreover, rising COVID-19 cases in China and Europe could further hinder the global recovery, especially if pandemic-related disruptions further strain supply chains. The recovery could also be derailed by a sudden tightening of global financing conditions, triggered by the need for much tighter monetary policy in major economies, especially if the war de- anchors inflation expectations (Figure 9.4.A and B). For the Western Balkans, a sudden tightening of external financing could generate risks associated with debt rollover and currency mismatches, especially in those economies that have substantial upcoming redemptions or that borrowed heavily in foreign currency. Global commodity prices have spiked further because of the war, pushing up inflation and sparking concerns about food security. Countries reliant on commodity imports, including those in the Western Balkans, are sensitive to global energy and food prices (Figure 9.4.C). Price increases this year have been particularly large for commodities where Russia and Ukraine are key exporters, including natural gas, coal, crude oil, wheat, aluminum, and palladium. Agricultural prices have increased over concerns that the war could further squeeze global grain supplies, as Russia and Ukraine account for a quarter of global wheat exports, and Russia and Belarus are key producers of fertilizer. Global food prices have reached a record high—exceeding the levels observed during the last two spikes in food commodity prices in 2007 and 2010—with higher natural gas prices doubling the price of fertilizer.36 As a result of these price spikes, an estimated 40 million people could be pushed into extreme poverty globally.37 Global goods and services trade are likely to come under additional pressure from the war. Although Russia and Ukraine account for less than 2 percent of global goods trade, the war and subsequent sanctions have frayed trade connectivity by disrupting transit routes, particularly for maritime container shipping and air freight traffic, while higher fuel prices have pushed up shipping 34 According to the January 2022 edition of World Bank’s Global Economic Prospects 35 OECD. 2022. OECD Economic Outlook, Interim Report March 2022: Economic and Social Impacts and Policy Implications of the War in Ukraine. OECD Publishing, Paris. 36 United Nations. 2022. Food price index hits record high in February, UN agency reports. https://news.un.org/en/story/2022/03/1113332 37 Mitchell, I., S. Hughes, S. Huckstep. 2022. Price Spike Caused by Ukraine War Will Push Over 40 Million into Poverty. How Should We Respond? 46  |  9. The post-pandemic rebound is cut short STEERING THROUGH CRISES Box 9.1 continued costs (Figure 9.4.D). The war is also likely to weigh on services trade and stall the post-pandemic recovery in international tourism, which was already anemic from ongoing COVID-19 disruptions. Outbound travel from Russia and Ukraine is expected to continue to be impacted by airspace closures, travel restrictions, sanctions, and increased fuel prices. The projected fall in tourists over security concerns and travel disruptions will further dampen the regional economy—tourists from Russia and Ukraine account for more than 10 percent of arrivals in about half of Europe and Central Asia’s economies, including those reliant on tourism in the Western Balkans, such as Montenegro and Albania. Activity in the euro area, the Western Balkans’ largest economic partner, was already expected to moderate in 2022 prior to the war. Even before the war, the euro area economy was facing headwinds due to a persistent drag from supply bottlenecks and stubbornly high oil and gas prices (Figure 9.4.E).38 Rising COVID-19 cases and hospitalizations since mid-March could cause further disruptions to activity, while closures of key Asian ports from COVID-19 outbreaks could put additional pressure on supple chains. While economic exposures of the euro area to Russia are small, the region is particularly dependent on energy and metals imports from Russia. Should Russian exports of crude oil or natural gas to Europe be curtailed, regional prices would spike further and push inflation higher. Direct financial spillovers are limited but will be felt mostly in advanced economies with exposure to Russian financial assets, including some Italian, French, and Austrian banks. Still, several international banks have exposure to the Russian economy through business ties and local presence. The war poses a material downside risk to euro-area activity, which has already prompted the European Central Bank (ECB) to lower its growth forecast by 0.5 percentage points this year and raise its inflation projection by nearly 2 percentage points.39 Although the conflict complicates monetary policy, market participants expect the ECB to delay rate hikes and proceed at a more gradual pace (Figure 9.4.F). Figure 9.4. Global economic developments A. Global financing conditions B. Consensus inflation forecasts Index, January 1=100 Percent 103 6 5 102 4 101 3 2 100 1 99 22 2 21 1 1 1 21 21 0 -2 -2 l-2 -2 n- p- v- n- ay ar ar Ju No 2019 2020 2021 2022 Se Ja Ja M M M ▬ Advanced economies ▬ EMDEs ▬ May 2021 ▬ Dec 2021 ▬ Feb 2022 ▬ Mar 2022 38 European Central Bank (ECB). 2022. Economic Bulletin Issue 8, 2021. ECB. 39 European Central Bank (ECB). 2022. Economic Bulletin Issue 2, 2022. ECB. 9. The post-pandemic rebound is cut short  |  47 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Box 9.1 continued Figure 9.4. Global economic developments (continued) C. CPI basket of goods, percent weights by D. Global manufacturing PMI new export orders component and shipping costs Percent Index, 50+=expansion Index 100=Jan 2019 60 60 800 50 50 600 40 30 40 400 20 30 200 10 20 0 0 Ap 19 Ju 9 Oc 19 Ja 19 Ap 20 Ju 0 Oc 0 Ja 20 Ap 21 Ju 1 Oc 21 Ja 21 ar 2 2 2 M n-2 -2 1 2 l-2 r- l- t- n- r- l- t- n- B M NE H R DA S R B V r- t- n- HR KO BG BL AL SR BI AR Ja M M J Housing, water, electricity, gas and other fuels ▬ New export orders ▬ Container shipping index, rhs J Food and non-alcoholic beverages E. Energy price impact on euro area growth F. Market-implied expectations of euro area policy rate hikes Percent Percent 0.1 0 0 -0.1 -0.2 -0.1 -0.3 -0.2 -0.4 -0.3 -0.5 -0.4 -0.6 22 2 22 2 22 22 22 22 22 -2 l-2 1 1 1 1 2 2 2 2 g- r- n- p- t- v- c- -2 -2 -2 -2 -2 -2 -2 -2 ay Ju Oc Ap No De Q1 Q2 Q4 Q3 Au Q1 Q2 Q4 Q3 Se Ju M J Gas J Oil Q Combined ▬ 10 Jan 2022 ▬ 10 Feb 2022 ▬ 10 Mar 2022 Source: Bloomberg; Consensus Economies; European Central Bank; Goldman Sachs; Haver Analytics; World Bank. Financial condition indices (FCI) are Goldman Sachs FCI constructed as a weighted average of short-term interest rates, long-term interest rates, the A.  trade-weighted exchange rates, an index of credit spreads, and the ratio of equity prices to the 10-year average of earnings per share. Sample includes 10 advanced economies (including euro area) and 12 EMDEs (excluding China). Aggregates are calculated are calculated using 2021 GDP weights at average 2010–19 prices and market exchange rates. Last observation is February 23, 2022. B. C onsensus Economics for median headline CPI inflation for 2021–22 using surveys for the months indicated. The sample includes 32 advanced economies and 50 EMDEs for December 2021 and May 2021 surveys, and 21 advanced economies and 38 EMDEs for the February 2022 survey. C. Data are as of January 2022. D. PMI manufacturing new export orders and Freightos global container shipping index. Last observation is February 2022. E. The impact of deviations in energy prices on euro area GDP net of exchange rate and policy effects, as calculated in ECB (2022). F. The projected policy rates for the euro area based on market-based expectations for hikes/cuts. While the short-term policy effort should to climate and disaster risks, as well as ensuring be focused on managing the unprecedented energy security (see Spotlight) could help boost crises impact, regionwide efforts on advancing potential growth. structural reforms and accelerating the low- carbon transition are needed. Addressing the In addition, prudent fiscal management low productivity, low labor force participation, at the time when financial markets started a substantial lag in governance effectiveness tightening would reduce sustainability risks. compared to its peers during the pre-accession On the revenue side, improving compliance period, and proactively building up resilience and increasing progressivity could boost 48  |  9. The post-pandemic rebound is cut short STEERING THROUGH CRISES revenues. On the expenditure side, enhancing targeting and efficiency of spending along with strengthening public investment management could help addressing sustainability but also strengthening the fiscal multiplier. 9. The post-pandemic rebound is cut short  |  49 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 10. Spotlight: Managing the Energy Crisis in the Western Balkans This Spotlight focuses on the current energy hubs40 have increased more than fivefold, from crisis in the Western Balkan countries (WB6) about EUR 18 per megawatt hour (MWh) to and outlines the policy responses adopted above EUR 100 per MWh, with a daily peak of by the governments to deal with the crisis. around EUR 227 per MWh on March 7, 2022.41 The Spotlight first discusses the unfolding of The day-ahead electricity prices on the Serbian the current energy crisis in Europe, its root Power Exchange (SEEPEX) also increased more causes, and the transmission mechanisms of than fivefold between March 2021 and March energy price increases on governments and final 2022, from about EUR 50 to about EUR 270 consumers. It then provides an assessment of per MWh, with a daily peak of around EUR the vulnerability of WB6 countries to energy 560 per MWh on March 8, 2022.42 Coal and price shocks and describes the impact of the oil prices have also been soaring. Thermal coal energy crisis in the WB6 countries, the measures prices in Europe exceeded US$450 per ton in adopted by the governments to mitigate it, and March 2022 compared to about US$50 per ton the fiscal impact of these measures. Finally, the a year before.43 Brent crude oil futures reached Spotlight presents policy recommendations to a 14-year high of US$139 in March 2022 governments in the context of the energy crisis compared to about US$30-US$40 in March that can be applied in the short, medium, and 2021.44 long term, and provides a qualitative assessment of how the current energy crisis can impact the The energy price hikes in Europe have been green energy transition going forward. caused by a combination of short-term and long-term factors that have led to demand and supply shifts, especially in the natural An Extraordinary Energy Price Shock Hit gas market. Short-term trends that have been Europe affecting energy prices include: After reaching nearly all-time lows in y The post-pandemic economic recovery, 2020, global energy prices climbed to which was accompanied by a higher-than- unprecedentedly high levels in the second expected surge in natural gas demand in half of 2021, with Europe being especially Europe at a time when power generation hard hit due to its dependence on natural gas from wind and hydro was unusually low and close linkages between electricity and due to weather conditions; natural gas prices. Since March 2021, market prices of natural gas in the European trading 40 Dutch TTF. 41 Trading Economics, https://tradingeconomics.com/commodity/eu-natural-gas (accessed March 2, 2022). 42 SEEPEX, Day-Ahead Electricity Prices. 43 Rystad Energy, https://www.rystadenergy.com/newsevents/news/press-releases/old-king-coal-price-reaches-highest-level-in-more-than-200-years- on-track-for-$500/. 44 Trading Economics, https://tradingeconomics.com/commodity/brent-crude-oil (accessed March 14, 2022). 50  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES y The surging global demand for liquefied than 60 percent in 2021;46 (ii) the coupling natural gas (LNG), especially in Asia; with the Asian gas market, due to the global surge in demand for liquified natural gas and y Inadequate gas reserves, with levels well the shift from long-term gas contracts to a spot below the average of past years at the market, encouraged by the EU’s Third Energy beginning of the heating season;45 Package;47 and (iii) the shift from oil indexation to gas-on-gas pricing, which exposes European y The rising price of the European consumers to market gyrations48. Union’s (EU’s) emission trading scheme allowances, which neared EUR 100 per Natural gas and electricity prices are likely ton of CO2 in early February 2022 and are to remain high throughout 2022. Although currently in the range of EUR 75–85 per the market remains clouded by significant ton of CO2; uncertainties, even the seasonal decline in gas prices in the spring is likely to leave prices y The coupling of gas and electricity prices, significantly higher in 2022 (roughly twice the as in many European countries the last average gas price observed in Europe in the marginal generation unit dispatched (that recent past). Electricity prices are expected to is the most expensive one setting the continue to closely follow gas prices (whereby clearing price) runs on natural gas; and gas-fired generators could be joined as marginal units by coal-fired plants) and remain high y More recently, the instability caused throughout 2022. The main elements that by the war in Ukraine and the related could cause additional variability include: (i) sanctions against Russia that invoked risks a prolonged war in Ukraine, with the related of disruption to natural gas, oil, and coal potential disruption of natural gas, oil, and coal supply. supplies; (ii) the need to replenish gas storage facilities in preparation for the next winter S  ome longer-term trends are also playing a season;49 (iii) further increases in gas demand as role in the recent energy price hikes in Europe, supply remains constrained; and (iv) changes in such as: (i) the declining production of natural national energy policies (e.g., bans on Russian gas in Europe (especially in the UK and the gas imports). Netherlands), and the subsequent higher dependence of European countries on natural Higher natural gas prices can impact retail gas imports (primarily from Russia), which energy prices in several ways. In countries increased from 45 percent in 2015 to more where natural gas is used for heating and 45 Storage sites owned or controlled by Russian Gazprom had particularly low storage levels at the start of the heating season (just 25 percent of their working storage capacity) and accounted for half of the EU’s 5-year storage deficit while representing just 10 percent of the EU’s total working storage capacity (source: IEA, https://www.iea.org/reports/russian-supplies-to-global-energy-markets/gas-market-and-russian-supply-2). 46 https://ec.europa.eu/commission/presscorner/detail/en/qanda_22_1512 47 See https://energy.ec.europa.eu/topics/markets-and-consumers/market-legislation/third-energy-package_en for more information. It should be noted that in the current context, the European Commission is encouraging a shift away from spot trade to long-term contracts to provide greater incentives for investment in LNG terminals. 48 Natural gas prices are more volatile because it is a highly seasonal and weather-dependent commodity which is used in many European industries which can in turn be affected by different macro- and sector-related shocks. 49 Under the newly issued EU gas storage policy, starting 1 October 2022, existing storage infrastructure in the EU territory should be filled up to at least 90 percent of their capacity by October 1 every year. 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  51 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 industrial applications, higher natural gas countries that show vulnerability to shocks import prices directly translate into higher costs in the price of imported natural gas.51 In the for gas-based utilities (notably district heating case of Serbia, natural gas is used mainly for or combined heat and power plants) and large industrial applications and heating (either in industrial consumers. In countries where individual gas boilers or in district heating natural gas is used for power generation, higher plants), while 84 percent of the gas consumed natural gas import prices can cause an increase in North Macedonia is used in combined heat in wholesale electricity prices when gas-fired and power and district heating plants.52 plants are the marginal power plants; these higher prices imply higher power procurement At the country level, several WB6 countries costs for distribution utilities. Gas and power show a high degree of vulnerability to utilities often directly pass the higher costs on increases in the price of electricity imports. to their customers served in the open market, Albania and North Macedonia rely on imports while for customers in the regulated market, for a significant share of their total electricity tariff adjustments first need to be approved by consumption (32 percent and 24 percent the regulator. in 2019, respectively), which makes them particularly vulnerable to price shocks in the regional wholesale electricity markets. Western Balkan Countries Have And while Kosovo’s domestic electricity Different Degrees of Vulnerability to supply essentially equals demand on average Energy Price Shocks throughout the year, the country faces a surge in demand in the winter due to the widespread At the aggregate level, Western Balkan use of inefficient electric heating, which forces countries show limited vulnerability to direct it to import significant amounts of electricity natural gas price shocks, due to the relatively during the winter months and exposes it small role played by natural gas in their to risks related to fluctuations in wholesale energy mix(Figure 10.1). All WB6 countries electricity prices. In addition, it is worth noting (except Albania) rely on domestic lignite for a the exceptional situation currently faced by large share of their total energy supply (from Serbia: the country has historically been able to 34 percent for Montenegro to 56 percent for meet its electricity demand through domestic Kosovo in 2019),50 while the role played by generation (mostly coal and hydro), but from imported natural gas in their energy mixes is late 2021, adverse meteorological conditions relatively small (or entirely absent in the case and accidents at several thermal power plants of Kosovo and Montenegro). Serbia and North have significantly reduced domestic coal Macedonia are the only two countries with production and generation output and forced a material share of natural gas in their total the country to import large amounts of energy supply (13 percent and 9 percent in electricity in late 2021 and early 2022. In 2019, 2019, respectively) and are, therefore, the only Montenegro was a net importer of electricity 50 Domestic coal production is in line with domestic consumption in all WB6 countries (except Albania, whose reliance on coal is negligible). In recent years, North Macedonia has imported modest quantities of lignite to compensate for the reduction in domestic production. 51 In Bosnia and Herzegovina, natural gas is mainly used for district heating in Sarajevo, where the price impact is felt, but at country level the significance of gas is low. 52 ERC, 2020 Annual Report. 52  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES Figure 10.1. Assessment of the vulnerability of WB6 countries to energy price shocks (for 7 percent of its consumption), but recent products for a large share of their consumption, data suggest that in 2021 domestic supply and which exposes them to risks related to price demand nearly matched,53 so the country’s fluctuations. In addition, gasoline prices are level of vulnerability to increases in wholesale already relatively high in the region, especially electricity prices remains relatively low. in Albania (about EUR 1.8 per liter) and Montenegro (about EUR 1.7 per liter).55 All WB6 countries are vulnerable to fluctuations in the price of crude oil and oil products. Oil plays a significant role in Ability to Absorb Energy Price Shocks the energy mix of all WB6 countries, due to and Mitigate their Transmission to its widespread use for transport. Oil and oil Consumers is Limited products account for a share of the total energy supply ranging from 23 percent in Bosnia and Residential consumers in the WB6 countries Herzegovina to 52 percent in Albania, but the have a limited ability to absorb higher energy only WB6 countries producing significant prices. Energy vulnerability is widespread in quantities of crude oil are Albania and the WB6. In 2019, North Macedonia had Serbia.54 As a consequence of the low domestic the highest share of households in Europe production and limited refining capacity, reporting that they could not keep their home WB6 countries rely on imports of oil and oil adequately warm (33.1 percent), but Kosovo, 53 Energy Community, “Impact of the Electricity Price Surge in Energy Community Contracting Parties and Measures Undertaken” (December 2021). 54 However, Albania exports a significant share of the crude oil it produces and imports most of the refined products that it consumes, which still exposes it to price fluctuations. 55 Global petrol prices for April 4, 2022, https://www.globalpetrolprices.com/gasoline_prices/ (accessed April 12, 2022). 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  53 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Montenegro, and Serbia also rank among the region particularly vulnerable to tariff increases. top 10 countries (Figure 10.2).56 The inability According to available Household Budget to keep their homes warm and the incidence Survey figures, the median household in the of arrears and late payments of bills are more Western Balkan countries spends between 7 common among low-income households, and 10 percent of their total budget on energy. suggesting that poor and vulnerable consumers In addition, when facing higher energy prices, often have more difficulty meeting their households in WB6 countries (especially the energy needs. For example, 48 percent of low-income ones) often switch to cheaper the lowest income decile households in energy sources, such as firewood or waste, for Serbia and 65 percent in Montenegro have heating thereby exacerbating negative local air arrears in utility services, compared to only pollution and health impacts. 8 and 17 percent, respectively, in the top decile. Forty-three percent of low-income Figure 10.3. Share of household consumption households in Albania, 68 percent in Kosovo, expenditure on electricity, gas, and other fuels is high, but even higher among the poor in and 68 percent in North Macedonia were in some countries arrears on utility bills compared to 27 percent, Percent 49 percent, and 34 percent on average in the 14 country, respectively.57 The relatively high 12 spending on energy makes households in the 10 8 Figure 10.2. Inability to keep the home 6 adequately warm 4 2019, percent of the population 2 0 ALB BIH KOS MNE SRB J Poorest decile J Median Sources: Household Budget Surveys, state statistical offices. Survey years: ALB (2020), BIH (2015), KOS (2017), MNE (2015), SRB (2019). Industrial customers in the WB6 countries are also vulnerable to higher energy prices, especially the ones in energy-intensive sectors. An indication of the higher vulnerability of industrial customers in the WB6 compared to other European countries is given by the energy intensity of the economy at purchasing power parity (PPP) exchange rates. According to Eurostat, in 2019 all WB6 countries (except J >20% J 10–20% J 5–10% J <5% J No data Albania) had a higher energy intensity of the Source: Energy Community, Study on Addressing Energy Poverty in the Energy Community Contracting Parties. economy than the EU27, the highest-ranked Note: Kosovo, UK, and Iceland data from 2018. countries being Bosnia and Herzegovina and 56 EUROSTAT, EU-SILC Survey. Data for Albania and Bosnia and Herzegovina not available. 57 Energy Community report on Energy Poverty. 54  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES Kosovo (0.093 and 0.078 tons of oil equivalent in the degree of exposure between utilities, (toe) per US$1,000 of GDP at PPP, respectively, households, and industrial consumers. compared to 0.055 toe for the EU27). High energy intensity can itself be a consequence of The higher wholesale electricity prices are persistently low energy prices, and the low-cost having a significant impact on power utilities domestic electricity supply based on lignite in all WB6 countries except Bosnia and and hydro, which has enabled WB6 countries Herzegovina and Montenegro. Electricity to maintain low prices for many years, results suppliers in net importing countries (Albania, in higher vulnerability at this time of crisis. Kosovo, North Macedonia, and, exceptionally Countries that have attracted high-energy in late 2021/early 2022, Serbia) are incurring industries such as aluminum, steel, or fertilizer huge losses and liquidity issues due to production (e.g., Bosnia and Herzegovina or skyrocketing costs of supplies purchased on the Serbia) see a higher share of their economy competitive market. In North Macedonia, it affected severely. In addition, low energy prices is reported that the government is subsidizing create long-term disincentives that hamper imports, or domestic electricity production in short-term energy conservation measures, the amount of EUR 171 million of budgetary operational improvements, and investments in funds as of April 1, 2022. In Albania, the energy efficiency. government has said that it will have to inject around EUR 550 million in 2022 to cover imported power. In Kosovo, unplanned Energy Prices Are Increasing Across the outages resulting in seasonal imports during Western Balkans December 2021 and January 2022 increased system costs by EUR 55 million. In Serbia, The different levels of vulnerability to energy the Deputy Prime Minister and Minister price shocks are translating into different of Mining and Energy estimated that the impacts on energy utilities and consumers additional costs of emergency electricity across WB6 countries. A synthetic assessment imports would be measured in the hundreds of the impacts of the increases in electricity and of millions of euros for the whole season58, natural gas prices in WB6 countries, without with up to EUR 500 million estimated to have considering the emergency measures adopted been spent by end February 2022. In addition by governments to alleviate such impacts, is to electricity suppliers, in several countries described in this section (see next section for a transmission and distribution system operators discussion of Government interventions). (TSOs and DSOs), which need to purchase electricity to cover losses in their networks, are facing exceptionally high costs. The notable Electricity exception is Bosnia and Herzegovina, which is a net exporting country; its electricity producers  able 10.1. summarizes the impact of T (especially coal generators) are reaping profits electricity price increases on different categories from electricity exports, also thanks to the fact of sector stakeholders, with notable variation that they are not subject to a carbon price. 58 Balkan Green Energy News, https://balkangreenenergynews.com/new-troubles-for-serbias-eps-coal-plant-tent-b-is-offline-amid-breakdown-fire/. 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  55 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Table 10.1. Assessment of the impacts of electricity price increases in WB6 countries on sector stakeholders Impact by Albania Bosnia and Kosovo Montenegro North Serbia Stakeholder Herzegovina Macedonia Utilities and Network Operators Universal Electricity Universal TSO and DSO Generation Power utility supplier producers supplier facing high company ESM EPS facing OSHEE reaping profits KESCO costs to cover facing higher higher costs incurring thanks to incurring network losses costs due to due to losses due to electricity losses due to increased gas increased the very high exports (and the very high prices. TSO reliance on import prices the absence of import prices. (MEPSO) and expensive carbon pricing) TSO KOSTT DSO (ENV) electricity facing high facing high imports costs to cover electricity (caused by network losses import prices unplanned outages) Household consumers (incl. low- No impact No changes Regulator No changes Regulator No changes voltage so far, but in electricity approved in electricity (ERC) in electricity commercial potential tariff tariffs tariff reform, tariffs increased tariffs consumers) increases but shielding electricity under households tariffs for consideration with lower households by consumption 9.5% levels from the increases Industrial consumers (served in the Directly hit by No changes Directly hit No changes Directly hit by Directly hit by open market) price increases in electricity by the price in electricity price increases price increases tariffs increases tariffs Note: DSO = distribution network operators; TSO = transmission system operators. Still, domestically, the increase in the cost end of 2021, the regulator (ERC) increased of production has not been compensated by household electricity prices by 9.5 percent. In matching tariff increases and a sector-wide loss February 2022, the Kosovar energy regulator of EUR 50 million is forecasted. (ERO) adopted a tariff reform that increased residential tariffs for electricity consumed above Residential consumers have been protected 800 kWh/month by about 80 to 100 percent to some extent from the increase in wholesale (depending on the time of use), while tariffs electricity prices, but pressure for tariff for consumption levels below 800 kWh/ adjustments in this segment is rising. Table month remained unchanged.59 In Montenegro, 10.1 shows that regulated electricity tariffs for the retail electricity market is deregulated for households have been kept mostly unchanged, households and small commercial consumers, though in some countries, regulators have but specific provisions in its energy law limit the approved special tariff adjustments or are potential increase in tariffs for these categories planning to do so. In North Macedonia, at the to 6 percent until the end of 2022, due to the 59 ERO, “Consultation Report on the Review of the Tariff Structure for Regulated Household Customers Supplied by USS” (January 17, 2022); Press review. 56  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES lack of competition in the market. However, Non-residential consumers in net importing tariffs have remained unchanged since 2019.60 countries (Albania, Kosovo, North Macedonia, and, exceptionally in the last months, Serbia) The persistently high electricity prices are the ones facing the highest increases in their on wholesale markets and the additional electricity bills, especially when they have to uncertainty related to the war in Ukraine renew their supply contracts. In Kosovo, several are putting increasing pressure on regulators industrial customers have reported delays in in the regions to allow tariff adjustments to payments, while one (the largest industrial pass at least a share of the higher costs on consumer) has temporarily ceased activity.62 to residential consumers. If and when that happens, households in the Western Balkans would feel an impact on energy affordability Natural Gas since they already spend a high share of household expenditure on energy (Figure 10.3). North Macedonia is feeling the greatest The poor may be particularly hurt, given the impacts of natural gas price increases. limited room for them to immediately adjust Combined heat and power and district heating consumption and fuel sources. For example, a plants in the Skopje area account for most previous simulation analysis for Serbia suggests of the gas consumed in the country and are that an electricity tariff increase by 16.3 percent currently facing steep cost increases (Table can lead to an increase in the household budget 10.2). At the end of 2021, ERC, the energy share for electricity by 0.5 percentage points regulator, approved an increase in district and an increase in the overall poverty rate by heating tariffs of 14 percent. While further 1 percentage point. Previous analysis for North increases are not confirmed, tariffs for both Macedonia suggests that poverty could go up household and industrial consumers are likely by 1.4 percentage points if electricity tariffs to increase significantly in the coming months increase by 10 percent. Previous simulation to reflect the higher gas import prices (end-user analyses for a potential increase in the electricity gas prices are deregulated for all consumers in tariff by 24 percent in Albania and 25 percent North Macedonia, and as of March 1, 2022, in Kosovo suggest that the household budget the imported gas price increased by about four share devoted to electricity will increase by times). Serbia has been only partially affected 1.1 and 1.3 percentage points for the poorest by the skyrocketing wholesale natural gas prices quintile, respectively.61 since most of its imports come from Russia through a long-term contract between Srbijagas Industrial consumers are served in the open and Gazprom. While the details of the supply market in all WB6 countries, so they are contract are not public, in November 2021, being directly hit by the price increases. Serbia and Russia agreed to maintain the 60 Energy Community, “Impact of the Electricity Price Surge in Energy Community Contracting Parties and Measures Undertaken” (December 2021). 61 World Bank (2016). “Serbia First Public Expenditure and Public Utilities Development Policy Loan”; World Bank (2019). “North Macedonia: Energy Affordability”; World Bank (2017). “Poverty and Distributional Impact of Electricity Tariff Reform on Vulnerable Households in Albania,” unpublished presentation; World Bank (2019). “Poverty and Distributional Analysis of Electricity Poverty and Protection of Vulnerable Customers in Kosovo,” unpublished report. 62 Energy Community, “Impact of the Electricity Price Surge in Energy Community Contracting Parties and Measures Undertaken” (December 2021). 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  57 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 natural gas price unchanged throughout the and 30 percent in 2020.65 While more recent heating season.63 Serbia expects to sign a new official data are not yet available, this trend 10-year gas supply arrangement with Russia by seems to have continued in 2021 and into mid-2022.64 However, partial exposure exists 2022, exposing Srbijagas to significant losses already: the share of imports through the long- in recent months due to the exceptionally high term contract with Russia has decreased over wholesale natural gas prices. the last few years, from 80 to 85 percent of gross natural gas consumption in 2015–16, to In addition to wholesale natural gas and 75 percent in 2019 and 55 percent in 2020. electricity prices, the prices of other energy This decrease has been offset by an increase in products (especially coal and oil) are also gas purchases on the regional wholesale natural rising on the regional wholesale markets. The gas markets, whose share has increased from impact of international coal price increases in zero percent in 2015–16 to 19 percent in 2019 WB6 countries is minimal, due to the almost Table 10.2. Assessment of the impacts of direct natural gas price increases in WB6 countries on sector stakeholders Impact by Albania Bosnia and Kosovo Montenegro North Serbia Stakeholder Herzegovina Macedonia Utilities and Network Operators Limited impact Significant Significant cost Utility incurring impact in increase for losses when selected areas district heating buying gas on with a higher and combined the wholesale reliance on gas heat and market. (e.g., Sarajevo, power plants Potential where gas relying on contractual prices went natural gas price increase up 37% in Q1 for imports 2022) after June 2022 Household consumers (incl. small No reliance on No reliance on Regulator Regulated commercial natural gas natural gas increased tariffs have so consumers) district heating far remained tariffs by 14%. unchanged Gas tariffs for HHs are deregulated and likely to increase significantly Industrial consumers (served in the Gas tariffs Limited impact open market) likely to so far. Potential increase price increase significantly after June 2022 63 According to the latest statement by the Director of Srbijagas, Dusan Bajatović, Serbia will import Russian gas at US$270 per 1,000 m3 until June 1, 2022. 64 Politika, https://www.politika.rs/scc/clanak/500961/Bajatovic-Ako-bi-neko-sad-zavrnuo-slavinu-imamo-rezerve-gasa-za-60-dana (accessed on March 3, 2022). 65 AERS, Annual Reports. 58  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES perfect balance between domestic production OSHEE until the end of the year, with a plan and consumption. Increases in the prices of to increase the fund by an additional EUR crude oil and refined products, however, have 100 million in 2022.66 In November 2021, a significant impact on the economy, since they the government of North Macedonia approved cause cost increases for transport, agriculture, the injection of EUR 65 million into energy manufacturing, and other sectors, pushing up companies, mainly the generation company the price of consumer goods and inflation. ESM and the TSO MEPSO, to increase their liquidity and subsidize increasing costs. At the end of 2021, total budget transfers to the power Policy Responses by Some Governments sector already amounted to EUR 86 million are Substantial (0.7 percent of GDP), and in February 2022 the government of North Macedonia The governments of WB6 countries have estimated that an additional EUR 193 million taken action to mitigate the impact of (1.5 percent of GDP) would be needed in the energy price hikes, but to different 2022.67 Furthermore, the government took extents, depending on the specific country’s over the heating provider until the end of the situation. For example, while Albania, Kosovo, heating season via the state-owned electricity and North Macedonia have declared a state producing company ESM. It also covered the of emergency, the governments of Bosnia cost between the current and actual heating and Herzegovina and its federal entities have prices. In December 2021, the government undertaken very limited measures so far. The of Kosovo provided a EUR 20 million direct measures adopted by the governments of the subsidy to the state-owned generation company WB6 countries in the context of the current KEK and returned the EUR 20 million in energy crisis fall into three main categories: dividends announced at the beginning of the (i) measures to provide financial support to year by the TSO KOSTT. In February 2022, the power sector; (ii) measures to mitigate the the government of Kosovo committed to impact of energy price increases on consumers, allocating EUR 100 million (about 1.3 percent especially the most vulnerable ones, and firms; of GDP) to subsidize electricity import costs and (iii) measures to reduce energy demand. and reduce the tariff increases proposed by the regulator.68 In Serbia, the government provided Several governments (for example in Albania, cash subsidies (in December 2021 totaling Kosovo, North Macedonia, and Serbia) have 0.5 percent of GDP) and extended lending provided financial support to the energy to the natural gas import and distribution sector. In October 2021, the government of company Srbijagas (in January 2022 in the Albania established a EUR 100 million fund amount of 0.4 percent of GDP). In addition, (corresponding to 0.7 percent of GDP) to the authorities extended state guarantees for provide liquidity and guarantees to the DSO loans to Srbijagas from commercial banks, 66 Balkan Green Energy News, https://balkangreenenergynews.com/albania-declares-energy-emergency-as-response-to-energy-crisis/ (accessed March 7, 2022). 67 Ministry of Finance, Republic of North Macedonia, “Economic and Fiscal Implications of the Energy Crisis on the Economy of North Macedonia (2021–2022)” (February 2022). 68 The regulator, ERO, had initially proposed an increase in residential electricity tariffs of 9 percent up to 600 kWh/month and more than 200 percent above 600 kWh/month. The government offered subsidies to keep tariffs unchanged up to 800 kWh/month and increase them by 80–100 percent above 800 kWh/month. 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  59 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 totaling up to EUR 200 million (about for companies at EUR75 per MWh (excluding 0.4 percent of GDP). the VAT) through June 2022. In addition, the government is working on a revised Decree on Governments have also adopted measures to Energy Vulnerable Consumers that will expand address affordability concerns and mitigate the coverage of the energy benefits, leading the impact of the energy price increases to an estimated increase in the number of on the most vulnerable consumers. The beneficiary households from about 62,000 to government of North Macedonia, for example, 200,000.71 Meanwhile, in February 2022, the has taken action to reduce taxes on electricity, authorities in Kosovo provided direct subsidies expand social assistance programs, and offer for electricity imports introduced to mitigate subsidized credit lines to companies. In July the tariff increase on households and firms. 2021, the government reduced the VAT rate on Specifically, prices of household consumption electricity from 18 percent to 5 percent, and under 800 MWh and commercial consumption plans to increase it to 10 percent by the end of were kept unchanged, and prices for household 2022 and back to 18 percent in July 2023.69 consumption above 800 MWh increased at The government also expanded the coverage of a lower rate than import prices. For these financial support for energy expenditures offered measures, the government has committed EUR to vulnerable households and beneficiaries 90 million (or 1.2 percent of GDP) in the of social pensions (with an expected cost of budget. EUR 5 million in 2022 compared to EUR 4 million in 2021). In addition, the Ministry To reduce the impact of the high prices of of Economy allocated EUR 1 million for energy imports, some governments have 2022 for an Energy Poverty Program.70 The also adopted measures aimed at reducing government of North Macedonia is also directly electricity demand in the short term. For supporting companies through liquidity example, in order to reduce electricity demand, loans and through loans for energy efficiency the government of Kosovo has adopted a set through the Macedonian Development Bank. of measures including: (i) the launch of an In Montenegro, in 2021, the government awareness-raising campaign to promote energy approved a temporary increase in the coverage savings, (ii) the reintroduction of block tariffs and subsidy amounts of the bill discount to discourage the use of electricity for heating, program, with a total cost of EUR 3 million and (iii) a ban on cryptocurrency mining. In provided by the state-owned power utility. addition, in December 2021, Kosovo was The government later approved the extension forced to briefly resort to power rationing, of the special subsidy program throughout also due to a drop in domestic generation: the 2022. In January 2022, the Government distribution company KEDS introduced power of Serbia reissued a recommendation to the outages of two hours’ duration every day for a state-owned power utility EPS (originally few days to curb electricity demand.72 introduced in November 2021) to cap the price 69 The expected cost is EUR17 million in 2021, EUR31 million in 2022, and EUR11 million in 2023. 70 Ministry of Finance, Republic of North Macedonia, “Economic and Fiscal Implications of the Energy Crisis on the Economy of North Macedonia (2021–2022)” (February 2022). 71 Balkan Green Energy News, https://balkangreenenergynews.com/rs/manji-racuni-za-struju-gas-i-grejanje-za-200-hiljada-domacinstava-u-srbiji/. 72 Reuters, https://www.reuters.com/markets/commodities/kosovo-introduces-power-cuts-due-energy-crisis-2021-12-22/. 60  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES Government Support Further Narrowed y On the demand side, measures largely Fiscal Space in Some Countries focused on supporting pensioners and Governments across the Western Balkans other vulnerable groups, firms, and energy have implemented a variety of measures with efficiency and installation of solar rooftops respect to oil, electricity, and gas price hikes, (in North Macedonia for example). Across in addition to food price hikes. The support the region, authorities increased the packages range from 0.2 percent of GDP in minimum wage and pensions. Montenegro to 4.9 percent of GDP in North Macedonia. To cushion the impact of rising Figure 10.4. Key macroeconomic indicators for energy prices, authorities have implemented WB6 countries measures on the supply and demand side. 2021, percent of GDP ALB -4.5 74.0 -7.7 y On the supply side, policies have taken BIH -2.5 36.6 -2.3 the form of fuel subsidies to farmers and public transport companies, price controls KOS -1.4 22.5 -9.1 of oil products, cuts in VAT rates on MNE -2.0 87.7 -9.2 energy products, and cuts in excises on oil MKD -5.4 60.8 -3.5 derivatives. In Albania, tax expenditures on farmers’ fuel consumption have been SRB -4.1 57.1 -4.4 extended, while in the Federation of J Fiscal balance J Public and publicly guaranteed debt Bosnia and Herzegovina farmers will J Current account balance receive 1.4 million liters of diesel fuel Source: MOF, Central banks, World Bank staff estimates. (50 liters per hectare) from existing stocks of commodity reserves at subsidized rates, A few Western Balkan countries have limited together with other agricultural subsidies. fiscal space and will need to revise their Agricultural subsidies also feature fiscal plans to accommodate the energy crisis prominently in Montenegro. Meanwhile, support. Two years into the extraordinary in Kosovo, agricultural diesel fuel is pandemic shock, the size of the new supply- and subsidized per acre planted, together with demand-side measures builds on already large subsidies for wheat, corn, and potato fiscal deficits in 2021 in some countries. Three fertilizers. In Albania, public transport countries stand out—Albania, Montenegro, companies received subsidies to prevent a and North Macedonia—and are expected to sizable price hike in bus fares. In Bosnia run a fiscal shortfall of over 5 percent of GDP and Herzegovina, the governments in in 2022, adding to the elevated debt levels. both entities limited retail and wholesale margins on oil and other products, while North Macedonia cut the VAT and excises Policy Options to Mitigate the Impact of on electricity, gas, and oil derivatives. In the Crisis and Build Resilience Kosovo, profit margins on diesel fuel were temporarily frozen, whereas in Serbia a Reviewing the measures implemented by maximum fuel price has been introduced the governments of the WB6 countries over and is adjusted monthly. the past few months, the policy options 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  61 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 available to governments in the context of Among the short-term measures that have a the energy crisis are twofold. There are short- significant fiscal impact, governments should term mitigation measures governments can prioritize the ones aiming at expanding take immediately to ensure energy affordability targeted social protection for vulnerable for vulnerable consumers and address the consumers, which have proven to be more negative effects of energy price hikes on energy- cost-effective and avoid distortionary effects. intensive industries. There are also medium- On the other hand, measures that shield to long-term actions that can build resilience consumers from the energy price increases by against energy price fluctuations while reducing keeping prices artificially lower than market dependence on fossil fuels. While the urgency prices or true costs (e.g., caps on energy for governments to act in the face of increasing prices or generalized tax breaks) have several energy prices is understandable, the efficacy, drawbacks that governments should be aware efficiency, and sustainability of different of, including (i) they put significant strain on measures vary and should be considered when the financial viability of the utilities and the adopting mitigating measures. fiscal budget; (ii) they tend to be regressive, benefitting the wealthy who consume more Short-term measures that governments have energy than others; and (iii) they cause adopted or could adopt to mitigate the distortions in consumption and the overall impacts of the energy crisis in the short term economy, disincentivizing investments in include: energy efficiency and clean energy, prolonging the vulnerability of economies to future price y Promoting energy conservation and shocks. For these reasons, when they cannot accelerating energy efficiency measures for be avoided, these measures should at least be both heating and electricity demand designed in a way to be time-bound, fully through awareness campaigns and budgeted, and transparent. financial incentives; y Providing targeted social protection (e.g., In the medium to long term, to build emergency income support, cash transfers) resilience against future energy price shocks, to vulnerable consumers; the governments of WB6 countries could y Implementing liquidity programs through adopt measures aimed at: public banks to support SMEs and critical industries (or extend and expand existing y Improving energy security, such as ones); (i) diversifying the sources of natural gas y Introducing temporary tax breaks, price imports and the supply routes involved; caps, or discounts/deferrals on utility bills (ii) expanding investments in energy for vulnerable households and industrial storage capacity (including natural gas customers; storage capacity, pumped hydro storage, y Stepping up market surveillance to ensure battery energy storage systems); and (iii) the transparency and integrity of the designing and implementing hydropower energy markets’ functioning. risk mitigation strategies to reduce risks of supply disruption related to climate change; 62  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES y Fostering regional integration and y Protecting the most vulnerable, by ensuring cooperation, such as (i) signing bilateral that assistance programs are in place to agreements with neighboring countries to support vulnerable consumers at risk of share gas reserves and promote electricity energy poverty. trade; and (ii) accelerating the creation of regional energy markets in the Western Across Europe and the whole world, there Balkans or coupling existing markets to are signs that in the short and medium take advantage of complementary firm term, the current energy crisis might slow and intermittent energy sources; down the green energy transition. The crisis has prompted governments to take emergency y Reducing domestic energy demand, by actions to ensure the security and affordability scaling up investments in energy efficiency of energy supply. However, in several cases, (which should be viewed as the “first these measures reverse previous policy decisions fuel of choice”), continuing efforts in and hamper efforts related to the green energy the public sector and introducing new transition. Among these emergency measures, initiatives to incentivize energy efficiency two that may have a significant impact on in the residential sector; slowing the green energy transition are the short-term return to coal and the delay of coal y Diversifying the energy supply mix, by phase-out plans, which several governments (i) scaling up investments in renewable across Europe (including Germany, the UK, energy (including bioenergy) and battery and Italy) are now resorting to. This trend energy storage, and tapping the potential can be seen in the Western Balkans as well, of decentralized renewables (e.g., the where some countries are either considering installation of roof-top solar PV on postponing their coal phase-outs (e.g., in North residential and commercial buildings), Macedonia) or might feel affirmed in their (ii) further transitioning from feed-in opposition to set clear timelines for abandoning tariffs to auction systems to harness global coal (e.g., in Bosnia and Herzegovina and competition and unlock lower-cost supply Serbia). In December 2021, the government options, and (iii) exploring the potential of North Macedonia launched negotiations for investments in new technologies such to buy 3 million tons of lignite from Kosovo as green hydrogen and biomethane; to feed its coal power plants and restarted the Negotino fuel oil-fired power plant, which had y Improving energy sector performance, by been dormant for twelve years.73 More recently, promoting sector reforms and enhancing the government has decided to delay the coal the operational efficiency and financial phase-out deadline from 2027 to 2030.74 In sustainability of utilities and service Bosnia and Herzegovina, the government of providers; the Federation of Bosnia and Herzegovina has decided to extend the operations of two units in the Tuzla and Kakanj coal plants, citing the 73 Reuters, https://www.reuters.com/markets/commodities/north-macedonia-eyes-3-million-tones-kosovo-coal-2021-12-10/. SeeNews, https:// seenews.com/news/n-macedonia-starts-up-tec-negotino-power-plant-report-765898. 74 Balkan Green Energy News, https://balkangreenenergynews.com/north-macedonia-delays-coal-exit-deadline-to-2030/. 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  63 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 need to limit the increase in electricity prices and face disproportionately higher risks related preserve the stability of the power system.75 In to climate change. In Serbia, for example, January 2022, Albania’s state-owned generation lignite is mined in open-cast operations company KESH issued a call for expression of surrounded by hills that shed large quantities interest for a contractor that would deploy and of floodwaters into the mines. In the case of operate a thermal power plant (TPP) with an another catastrophic flood, similar to the one installed capacity of 110-130 MW near the that occurred in 2014, the national utility EPS Vlora TPP, in order to guarantee the security of will likely suffer dire consequences. the power supply.76 To make the transition away from coal In addition, the energy crisis could make possible, WB6 countries should first carry Western Balkan governments reluctant to out comprehensive pre-closure activities. proceed with introducing some form of These activities include: (i) diversifying the carbon pricing as a means to account for economies around the mines, (ii) planning the environmental cost of fossil fuels and for potential labor redundancies with to set clear incentives to decarbonize and workers and communities, (iii) performing spur innovation, productivity growth, and the environmental remediation of a vast diversification through the deployment of acreage of land, and (iv) crowding in new renewable energy and energy efficiency. investments through the repurposing of land However, this could perpetuate a condition and infrastructure assets on already abandoned (common in Western Balkan countries) in mines. All this should happen before which low domestic energy prices (especially transitioning away from coal production. for coal and electricity) reduce the incentives to improve energy efficiency and sector At the same time, the energy crisis has performance, and countries are exposed to strengthened the interest in clean energy greater risks associated with future energy price sources and energy efficiency as a means of volatility because of the high energy intensity of diversifying the supply mix and enhancing their economies. energy security. As signatories to the Sofia Declaration on the Green Agenda for the Western Looking at longer-term trends, coal Balkans, aligned with the EU’s Green Deal, generation is becoming increasingly WB6 countries have committed to working hard to defend even in the coal-rich toward the 2050 target of a carbon-neutral WB6 countries, due to growing concerns continent together with the EU. In recent years, about the environment and air pollution, all WB6 countries have shown a commitment to external pressure (including the EU Carbon stepping up efforts to address several challenges Border Adjustment Mechanism), as well as related to the decarbonization of the energy analytical evidence showing that renewable sector. All WB6 countries have taken action energy is becoming (or already is) the least- to strengthen their regulatory frameworks and cost generation option. Moreover, utilities set up financial mechanisms to support the 75 Balkan Green Energy News, https://balkangreenenergynews.com/goverment-of-fbih-intends-to-extend-operation-of-two-units-in-coal-power- plants-kakanj-tuzla/. 76 Euractiv, https://www.euractiv.com/section/politics/short_news/albania-seeks-to-restart-thermal-power-plant-amid-energy-crisis/. 64  |  10. Spotlight: Managing the Energy Crisis in the Western Balkans STEERING THROUGH CRISES deployment of utility-scale renewable energy, different forms of distributed clean generation such as rooftop solar photovoltaics (PV), and the adoption of sustainable heating systems and energy efficiency measures. Despite the current challenging context in the energy sector, there is hope that the scale-up of clean energy and energy efficiency will keep gaining momentum over the next years and decades. 10. Spotlight: Managing the Energy Crisis in the Western Balkans  |  65 Country Notes STEERING THROUGH CRISES Albania • Growth in 2021 fully recovered from the recession caused by the pandemic. At preliminary 8.5 percent, growth turned out to be considerably stronger than anticipated due to policy stimulus and resumption of travel, construction, and extractives. • At the same time, aligned with global developments, inflation has increased above the central bank’s target. • Due to a large nominal growth of GDP and a strong revenue performance, higher public spending was not translated into a higher debt-to-GDP ratio. • Employment and labor force participation have yet to catch up with their pre-pandemic levels, notwithstanding the strong growth outcome. • The short-term outlook deteriorated, and downside risks intensified. Uncertainty with regard to the war in Ukraine is affecting price stability and growth, which is expected to decelerate to 3.2 percent in 2022 if the acute phase of the crisis eases in Q2 2022. Recent Economic Developments sectoral composition of growth. Construction contributed 1.9 percentage points to the In 2021, the recovery gained speed. Real growth, supported by reconstruction and GDP increased by 8.5 percent, fully recovering government infrastructure spending. Of all from the recession caused by the pandemic. sectors, agriculture had the least contribution, Government spending and strong private due to increases in production costs. demand led growth, stimulated by continued monetary and fiscal policy support. Domestic Growth has not brought employment to demand contributed 9.4 percentage points the precrisis level. There were 16,800 fewer to growth, of which private consumption employed people in 2021 than in 2019. All contributed 4.7 percentage points, as consumer sectors except ICT, construction, transport, confidence improved, uncertainty regarding the retail and wholesale, and utilities have reduced pandemic was reduced, and disposable income employment since 2019. At the same time, increased through higher wages and bank average labor force participation fell for the lending. Gross fixed capital formation added second consecutive year among all age groups. 4.8 percentage points to growth, through both Wage pressures intensified: the formal real higher public and private investments. While wage increased by 3.7 percent in 2021, close exports expanded by 61.8 percent in 2021, the to the 2019 increase, while the minimum wage contribution of net exports was negative due to increased by 13.1 percent in real terms. The the high import content of growth. average unemployment rate remained stable at 11.5 percent in 2021. Growth in 2021 was broad-based. However, post-earthquake reconstruction, a strong Inflationary pressures have risen since late recovery of tourism and extractives, and 2021. Consumer price inflation reached favorable hydrological conditions for energy 3.7 percent in January 2022, led by wage production were key factors determining the pressure from the domestic demand expansion Albania  |  67 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 and the hike in food, energy, transport, and back of investments into extractives, banking, commodity prices in world markets. Food and telecommunications. This, together with prices increased by 6.8 percent year-on-year in government borrowing, financed most of the December 2021, close to double the increase current account deficit. The reserve coverage of the overall basket. This will hurt most stands at 8.2 months of imports of goods and households as food comprises over half of total services. consumption for the median household. The fiscal deficit has declined to 4.5 percent The central bank has increased the policy of GDP in 2021 due to strong revenues. rate by 0.5 percentage points in March 2022, Fiscal revenues rose to 27 percent of GDP in and announced further tightening in 2022. 2021, in line with stronger economic activity The exchange rate remained stable over 2021 and the abolishment of temporary tax relief with a slight appreciation toward the end of measures that were put in place during 2020. the year. However, with the start of the war in The main contribution came through the Ukraine and the rapid increase in commodity VAT collected on imported goods. Higher and energy prices, there were some short- fiscal revenue collection and new debt allowed lived depreciation pressures for the domestic the government to increase infrastructure currency which, as of now, have faded away spending. In addition, to ensure stable energy completely. supply during the last quarter of the year, the government increased subsidies to the energy Credit to the private sector grew strongly state-owned enterprises (SOEs) to cover during 2021 for both enterprises and increased energy import costs. Contingent households. Credit to the private sector liabilities from SOEs represent a source of risk increased by 8.5 percent in nominal terms for the budget as guarantees for the SOEs in the in 2021. Similarly, bank deposits continued energy sector are expected to increase further to expand by 10.3 percent, with household as the international prices increase and there is savings forming around two-thirds of growth no planed increase in tariffs for the regulated of total deposits in the system. costumers (households and small businesses). The current account deficit narrowed to Public debt declined in 2021 reaching 7.7 percent of GDP in 2021 from 8.5 percent 74 percent of GDP.1 A Eurobond amounting of GDP in 2020. The rebound in exports at to EUR 650 million was issued in November 61.8 percent y/y was sizable after their decline 2021 to pre-finance the gross financing needs in in 2020, and led to a significant narrowing of 2022. The rating for the country was confirmed the trade deficit by 1.1 percentage points of at B1/stable by Moody’s and and B+/Stable by GDP. The services account (at 11.5 percent of S&P at the start of 2022. GDP) and remittances (at 4.9 percent of GDP) helped narrow the current account deficit in 2021. Net foreign direct investment increased in 2021 reaching 6.4 percent of GDP on the 1 Includes the stock of arrears to the private sector reported as per December 2021 in the amount of 15.4 billion lek. 68  | Albania STEERING THROUGH CRISES Outlook and Risks Albanian exports to key EU trading partners that account for 60 percent of its exports. In Economic growth is expected to decelerate this case, the government may need to cut to 3.2 percent in 2022 under the baseline capital spending to prevent an increase of scenario. This rests on the assumption that the the debt-to-GDP ratio. Moreover, with more acute phase of the crisis eases in Q2 2022 even reliance on external financing, the exchange if effects of sanctions persist through 2022 and rate, interest rate, and refinancing risks remain even into 2023. elevated. A key medium-term reform priority is the need to boost revenue collection and However, the war in Ukraine, if prolonged, achieve fiscal consolidation, while allowing for could affect the Albanian economy through significant growth-enhancing spending. several channels. Higher commodity prices, in particular oil and grains, are expected to Over the medium term, growth is projected to be the main transmission channel. In general, accelerate to 3.5 percent. Private consumption direct trade, remittance, and migration linkages is projected to return as the primary driver of with Russia and Ukraine are small, accounting GDP growth. Private investment could provide for less than 3 percent of the total. However, further support to growth if business climate Russia and Ukraine are key producers and reforms are implemented. The current account exporters of several commodities which are deficit is expected to narrow over the medium of vital importance for Albanians including term, as service exports, including tourism and grains. Higher energy prices are expected fast-expanding business process operations, are to drive up prices in transport, and lead to expected to grow in line with pre-pandemic second round effects in other goods of the trends. consumption basket. Inflation is expected to increase to 5.5 percent in 2022 from a pre- conflict scenario of 3 percent. With higher import costs, the current account deficit is likely to grow to 7.9 percent of GDP. As higher costs reduce household purchasing power and raise the costs of businesses, growth prospects are also lower. If higher energy prices translate into higher electricity import prices, the shock could also deteriorate the financial situation of Albania’s electricity SOEs. This could heighten fiscal risks from the energy SOEs. The public debt is expected to stabilize at 73.9 percent of GDP in 2022, before declining gradually over the medium term. Fiscal space could further deteriorate in a downside scenario where prolonged war further decelerates EU growth and thereby lower Albania  |  69 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 The GDP recovered well in 2021, but the Despite higher growth, labor markets are yet to speed of recovery moderated toward year-end. recover. Economic Sentiment Index (lhs) and GDP growth (rhs) Percent 120 20 62 100 15 60 10 58 80 5 56 60 0 54 40 -5 52 20 -10 50 0 -15 48 8/ 7 11 17 2/ 7 5/ 8 8/ 8 11 18 2/ 8 5/ 9 8/ 9 11 19 2/ 9 5/ 0 8/ 0 11 20 2/ 0 5/ 1 8/ 1 21 2 2 1 /1 Q 4 17 Q1 17 Q2 8 Q 3 18 Q4 8 Q1 8 Q 2 19 Q3 19 Q4 9 Q1 19 Q2 0 Q3 20 Q4 20 Q1 0 Q2 21 Q3 1 1 1 1 /1 1 1 /1 2 2 /2 5/ -2 -2 -1 -1 -1 -1 -2 -2 - - - - - - - - - Q3 J GDP growth, rhs ▬ Economic sentiment index, lhs ▬ Labor force participation rate ▬ Employment rate Source: INSTAT and Bank of Albania. Sources: INSTAT. The public debt decreased... ...while the current account deficit narrowed. Share in GDP Share in GDP 90 0 80 -2 70 -4 60 50 -6 40 -8 30 -10 20 10 -12 0 -14 p p 10 11 12 13 14 15 16 17 18 19 10 11 12 13 14 15 16 17 18 19 20 20 21 21 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Source: Ministry of Finance. Source: Bank of Albania. Credit to the economy has supported growth. Headline and core inflation have accelerated since April. Percent change, yoy Percent, y/y 12 4 10 3 8 2 6 4 1 2 0 0 -1 -2 -4 -2 16 16 17 17 18 18 19 19 20 20 21 21 22 3 12 4 4 12 5 5 12 6 6 12 7 6/ 7 12 8 8 12 9 6/ 9 12 0 0 21 1 /2 1 /1 /1 1 /1 1 /1 1 /1 1 /1 1 /1 2 /2 7/ 1/ 1/ 7/ 1/ 7/ 1/ 7/ 1/ 7/ 1/ 1/ 6/ 7/ 6/ 6/ 6/ 6/ 6/ 12 12 ▬ Inflation (CPI) ▬ Core inflation Source: Bank of Albania. Source: Bank of Albania. 70  | Albania STEERING THROUGH CRISES ALBANIA 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) 2.2 -3.5 8.5 3.2 3.5 3.5 Composition (percentage points): Consumption 2.5 -2.6 4.5 2.0 2.4 2.0 Investment -0.9 -0.9 4.8 0.3 0.1 1.1 Net exports 0.6 0.0 -0.9 0.9 1.0 0.4 Exports 2.0 -9.4 11.5 1.5 2.4 2.1 Imports (-) 1.4 -9.3 12.4 0.6 1.4 1.7 Consumer price inflation (percent, period average) 1.4 1.6 2.6 5.5 4.0 3.0 Public revenues (percent of GDP) 27.2 25.9 27.0 27.1 27.2 27.3 Public expenditures (percent of GDP) 29.2 32.6 31.5 32.1 29.9 29.6 Of which: Wage bill (percent of GDP) 4.6 4.7 4.4 4.4 4.4 4.2 Social benefits (percent of GDP) 11.9 12.9 12.6 11.8 11.7 11.4 Capital expenditures (percent of GDP) 4.5 6.2 6.8 5.4 4.6 4.6 Fiscal balance (percent of GDP) -1.9 -6.7 -4.5 -5.0 -2.6 -2.4 Primary fiscal balance (percent of GDP) 0.1 -4.6 -2.6 -2.5 -0.1 0.1 Public debt (percent of GDP) 63.7 74.0 72.1 72.0 70.2 69.0 Public and publicly guaranteed debt (percent of GDP) 67.4 75.9 74.0 73.9 72.1 70.9 Of which: External (percent of GDP) 29.1 35.9 37.8 37.0 37.0 37.0 Goods exports (percent of GDP) 6.6 6.0 8.2 6.8 6.7 6.7 Goods imports (percent of GDP) 29.7 28.4 33.0 30.2 29.8 29.5 Net services exports (percent of GDP) 9.3 8.1 11.5 11.3 12.6 13.3 Trade balance (percent of GDP) -13.8 -14.4 -13.3 -12.1 -10.5 -9.5 Net remittance inflows (percent of GDP) 5.2 5.1 4.9 4.8 4.8 4.8 Current account balance (percent of GDP) -8.0 -8.5 -7.7 -7.9 -6.4 -5.3 Net foreign direct investment inflows (percent of GDP) 7.6 6.7 6.4 6.4 6.3 6.3 External debt (percent of GDP) 60.0 65.6 58.1 56.7 57.0 56.9 Real private credit growth (percent, period average) 1.5 5.2 5.5 - - - Nonperforming loans (percent of gross loans, end of period) 8.4 8.1 5.7 - - - Unemployment rate (percent, period average) 11.5 11.7 11.5 - - - Youth unemployment rate (percent, period average) 21.5 20.9 20.9 - - - Labor force participation rate (percent, period average) 60.4 59.5 59.8 - - - GDP per capita, PPP (current international $) 15,393 14,888 17,245 18,369 19,487 20,576 Poverty rate (percent of population) 28.1 31.3 22.0 19.4 16.9 - Sources: Country authorities, World Bank estimates and projections. Note: Youth unemployment rate is for labor force aged 15–29. Statistical discrepancy contribution is divided at the ratio of 80 percent and 20 percent between Consumption and Investment respectively. Change in inventories is included in Investments. Poverty rate calculations based on ECAPOV harmonization using SILC-C data. Nowcasted/projected values start in 2020. Income measures in the SILC and consumption measures in the HBS are not strictly comparable. Poverty is defined as living on less than $5.5/day per person in revised 2011 PPPs. Albania  |  71 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Bosnia and Herzegovina • While political tensions stalled reforms, economic growth in 2021 reached 7.1 percent, outperforming expectations, after a short-lived recession the year before. • Headline inflation, meanwhile, accelerated fueled by food and transport prices. • Despite the surge in real growth, employment improved only marginally; unemployment remains elevated and is especially high among youths. • Fiscal revenues benefited from the strong rebound in growth, but the fiscal stance recorded a deficit of roughly 2.5 percent of GDP. • Under the baseline, real output growth is preliminary assessed at 2.7 percent in 2022 and is expected to increase over the medium term as the implementation of structural reforms slowly takes off; in the downside scenario of extended crisis, growth would decline further due to a dampening effect of lower business and consumer confidence, a slowdown in EU export demand, and more persistent inflation reducing disposable income. Recent Economic Developments The consumer price index (CPI) soared to 6.3 percent in December (y/y), continuing Following a contraction in 2020 of upward inflationary pressures that started 3.1 percent, the rebound in real GDP growth around mid-2021 due to strong consumer surprised on the upside in 2021. Economic demand, global supply bottlenecks, and a high growth accelerated to 7.1 percent (preliminary) passthrough effect given the currency board largely driven by the low base from the arrangement. Food price inflation, meanwhile, previous year marked by the pandemic crisis. skyrocketed to 10.8 percent in December (y/y) Nonetheless, this is an exceptional growth resulting in an annual food inflation rate of performance, which helped real GDP exceed 3.7 percent in 2021, by far the highest rate since the precrisis level. Real growth was driven 2016. Vegetable prices rose over 40 percent by a surge in exports, and robust growth in and edible oils rose close to 30 percent (y/y) private consumption. On the production side, in December 2021. In parallel, transport prices wholesale and retail trade rebounded strongly accelerated to over 14 percent toward the end from the large decline in activity seen in the of 2021 as prices of diesel and super petrol grew second and third quarters of 2020, while just over 30 percent (y/y) in the fourth quarter real growth in manufacturing accelerated in of 2021, with spillover effects to other products response to higher export demand. bolstering inflationary pressures in early 2022. In tandem with growth, inflation accelerated. The labor market improved, but the In 2021, headline inflation in Bosnia and unemployment rate remains elevated. The Herzegovina rose to 2 percent compared to a unemployment rate fell from a 19.1 percent deflation rate of 1.1 percent the year before in Q1 2021 to 16.4 percent in Q3 2021, and an inflation rate of 0.6 percent in 2019. driven by a rise in demand for labor.2 Job 2 The methodology of the Labor Force Survey was changed in 2021, which somewhat distorts direct comparisons between 2021 and 2020 data. 72  |  Bosnia and Herzegovina STEERING THROUGH CRISES gains in agriculture and construction drove up The sharp rise in exports narrowed the the employment rate to 40.4 percent in Q3 traditionally large, structural merchandise 2021, which nevertheless remains at low levels deficit, and helped narrow the current compared to other Western Balkan countries. account deficit (CAD). The CAD narrowed In parallel to the tightening of the labor market, from 3.9 percent in 2020 to a preliminary net nominal salaries rose about 4.3 percent in 2.3 percent in 2021 as the merchandise trade 2021, yet the swift rise in consumer prices deficit narrowed, while the services surplus in the fourth quarter of 2021 has eaten into widened compared to the year before. The households’ real incomes. sharp rise in exports benefited from strong demand and a rise in terms of trade for base Buoyant indirect revenues and sluggish metals (steel, iron, and aluminum), mineral capital spending were insufficient to return and wood products, machinery, and furniture. the fiscal balance to a surplus in 2021, Meanwhile, stronger tourism receipts and after the pandemic-induced deficit. The remittances helped finance the trade deficit. latest preliminary consolidated data indicate Close to 80 percent of the CAD is expected to a 2.5 percent of GDP fiscal deficit in 2021, be financed by net direct investments, while the compared to a deficit of 1.8 percent in 2020.3 total external debt-to-GDP ratio is projected to In 2021, revenues rose on the back of stronger remain below 66 percent in 2021. collection of the VAT. Meanwhile, higher expanses on goods and wages, as well as Except for one bank, the banking sector is social transfers, such as pensions and veteran liquid and well-capitalized. The market share benefitsraised expenditures, while capital of the Russian-owned Sberbank in BiH, that spending remained low. Implementation came under pressure following the introduction delays in public investments were triggered of sanctions against Russia, is 6.8 percent (in by difficulties in forming the government FBiH 6.3 percent and in the Republika Srpska in the Federation (FBiH) and country-level 11.7 percent). Recently imposed sanctions BiH Institutions (IBiH). Specifically, both entail, among others, the removal of selected the BiH Fiscal Council and FBiH Parliament Russian banks, from the SWIFT messaging adopted with a significant delay the Global system, disconnecting them from the Fiscal Framework for 2022–24 and the FBiH international financial system and limiting their budget, respectively. The budget for IBiH ability to operate globally. In light of resulting for 2022 has not yet been adopted, which liquidity difficulties, on March 1, ASA Finance means that IBiH is operating based on the Group (ASA Bank) bought Sberbank in FBiH, temporary financing schedule, which limits and a day later Nova Banka bought Sberbank in the scope of spending. FBiH was operating Republika Srpska. Thus, potential risks for the under a temporary financing schedule in the financial sector stemming from difficulties with first quarter of 2022. Total public debt remains Sberbank have been rapidly contained. The moderate at around 34.4 percent of GDP at banking system is well equipped to cope with end-2021, and predominantly consists of loans the shock as the systemwide nonperforming from international financial institutions. loan ratio has declined to 5.5 percent of total 3 See global fiscal framework for 2022–24, BiH Ministry of Finance and Treasury. Bosnia and Herzegovina  |  73 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 loans in 2021Q3, and profitability improved and therefore inflationary pressures may persist with a return on equity of 11.5 percent, up from longer than previously anticipated. 6 percent at the end of 2020. The capital-to- asset ratio remained unchanged, while capital The fiscal deficit in 2022 is expected to be buffers are within regulatory requirements. driven by capital and pre-election spending, and a return to surplus is envisaged in 2023. Without access to international markets, the Outlook and Risks authorities will continue relying on support from international financial institutions. The Real GDP is projected to decelerate to extent of this financial support will depend 2.7 percent in 2022, and average below on internal political developments and the 3.5 percent over the medium term. According de-escalation of tensions, which have risen to the baseline scenario, which considers a significantly over the past 10 months. contained war in Ukraine, BiH will not catch up with the pre-pandemic growth trajectory A downside scenario entails a more extended over the medium term. Output growth is war in Ukraine, which could reduce real expected to be driven by investment and a output growth in 2022 by 0.2 percentage more moderate rise in exports, which in turn points to 0.4 percentage points. An extended are likely to be more than offset by imports crisis would have a negative impact on aggregate as infrastructure projects ensue. Announced demand through lower business and consumer investments in energy and infrastructure are confidence in BiH and slower growth in the envisaged to lead the recovery phase together EU. The latter would have adverse spill-over with a further pickup in private consumption effects for BiH’s export demand. At the same fueled by remittances, a tightening labor time, however, price and volume effects for market, and domestic lending. As the impact of BiH’s exports of iron and steel products and the pandemic and hostilities in Ukraine subside, aluminium, which accounted for almost the political paralysis in BiH is expected to be 15 percent of total exports in 2021, could help overcome in the post-election period. Thus, the meet the shortages in the world market created Socio-Economic Program,4 fulfilling priorities by the hostilities in Ukraine, and in part offset for EU accession, is assumed to gain needed the negative effects of a slowdown in EU growth. attention by end of 2022, accompanied by Slower growth in the EU would likely also much-needed structural reforms. slow remittances, with negative consequences for household incomes, thus dampening With the global energy market disrupted over consumption in BiH over the medium term. the short term under a scenario of contained In addition, the rise in main commodity prices war in Ukraine, inflationary pressures are traded internationally, such as wheat, oil, and assumed to subside in the second half of natural gas, could prolong inflationary pressures 2022, leaving inflation around 6.5 percent. in the EU, thus impacting inflation in BiH due Energy and food prices may destabilize over the to the currency board arrangement. As a result, next few months due to the war in Ukraine, inflation could remain elevated throughout 4 The country’s medium-term development plan adopted in January 2020 to tackle key structural reforms and respond to EU accession priorities 74  |  Bosnia and Herzegovina STEERING THROUGH CRISES the year, totalling 10 percent compared to the baseline of 6.5 percent, further slowing private consumption as real disposable income declines. Beside the risks associated with the war in Ukraine, two other risk factors continue to dominate the BiH outlook. First, a prolonged impact of the pandemic as the virus continues mutating could adversely affect economic activity, and second, the existing political frictions could aggravate post- election difficulties in forming governments. Political frictions could even further intensify if geopolitical tensions shift to the Western Balkans. This would result in a more sustained detrimental impact on the implementation of structural reforms needed for EU accession. Bosnia and Herzegovina  |  75 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 GDP growth expanded in 2021. Post-crisis growth trajectory unlikely to close gap with respect to precrisis growth path. Contributions to growth, percentage points of GDP In 2015 KM, real GDP level (billions) 8 37 36 6 35 4 34 33 2 32 0 31 30 -2 29 -4 28 2018 2019 2020 2021p 2022f 2023f 2016 2017 2018 2019 2020 2021p 2022f 2023f J Agriculture J Industry J Services Q Real GDP growth ▬ GDP pre-pandemic ▬ GDP post-pandemic Sources: BiH Agency for Statistics; World Bank. Source: World Bank staff estimates. Consumer price and food inflation accelerated The fiscal balance remained in deficit in 2021. in 2021. Percent y/y Percent of GDP 7 2.5 6 2.0 5 1.5 4 1.0 3 0.5 2 0 1 -0.5 0 -1 -1.0 -2 -1.5 -3 -2.0 -2.5 18 18 10 8 8 19 19 10 9 9 4/ 0 20 10 0 0 4/ 1 21 10 1 1 2 2 /2 1 /1 1 /1 2 2 /2 1/ 7/ 1/ 4/ 7/ 1/ 4/ 7/ 1/ 7/ 2016 2017 2018 2019 2020 2021p 2022f 2023f ▬ Headline inflation ▬ Food prices J General government fiscal balance Sources: BiH Agency for Statistics; World Bank. Sources: BiH fiscal authorities; World Bank staff estimates. Indirect tax revenues continue to increase with Nonperforming loans in commercial bank slight slowdown toward end-2021. portfolios remain high. Real 3-month moving average (3mma), percent y/y 40 20 18 30 16 20 14 10 12 10 0 8 -10 6 4 -20 2 -30 0 -2 18 18 10 8 8 19 19 10 9 9 4/ 0 20 10 0 0 4/ 1 21 10 1 1 Q3 13 Q1 13 Q3 4 Q1 14 Q3 15 Q1 15 Q 3 16 Q1 16 Q 3 17 Q1 7 Q3 18 Q1 8 Q 3 19 Q1 9 Q3 20 Q1 20 Q3 21 1 2 2 /2 1 /1 1 /1 2 2 /2 -2 -1 -1 -1 -1 1/ 7/ 1/ 4/ 7/ 1/ 4/ 7/ - 1/ 7/ - - - - - - - - - - - - Q1 ▬ Growth in total indirect revenues (in 2010 prices, 3mma yoy) J Capital adequacy (tier 1 capital to risk weighted assets) ▬ Growth in net indirect revenues (in 2010 prices, 3mma yoy) ▬ Asset quality (NPLs to toal loans) ▬ Profitability (return on equity) Sources: BiH Indirect Tax Office; World Bank. Sources: Central Bank of BiH; World Bank calculations. 76  |  Bosnia and Herzegovina STEERING THROUGH CRISES BOSNIA AND HERZEGOVINA 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) 2.8 -3.1 7.1 2.7 3.1 3.5 Composition (percentage points): Consumption - - 4.9 2.4 2.8 3.1 Investment - - 1.0 -0.3 0.7 0.5 Net exports - - 1.2 0.6 -0.3 -0.1 Exports - - 14.2 3.8 3.2 3.8 Imports (-) - - 13.0 3.1 3.5 3.9 Consumer price inflation (percent, period average) 0.6 -1.1 2.0 6.5 2.3 0.5 Public revenues (percent of GDP) 42.6 42.2 42.3 40.5 40.4 40.5 Public expenditures (percent of GDP) 40.6 44.0 44.8 41.7 40.2 39.4 Of which: Wage bill (percent of GDP) 10.6 11.5 11.2 10.7 10.3 10.2 Social benefits (percent of GDP) 14.8 20.0 19.8 18.2 17.9 17.7 Capital expenditures (percent of GDP) 2.9 3.2 3.7 3.5 3.0 2.7 Fiscal balance (percent of GDP) 1.9 -1.8 -2.5 -1.2 0.2 1.1 Primary fiscal balance (percent of GDP) 2.6 -1.1 -1.7 -0.4 1.1 2.1 Public debt (percent of GDP) 32.8 36.6 34.4 33.2 34.0 35.3 Public and publicly guaranteed debt (percent of GDP) 34.5 38.8 36.6 35.1 36.0 37.5 Of which: External (percent of GDP) 28.4 30.8 28.8 27.4 27.8 28.4 Goods exports (percent of GDP) 28.8 27.5 34.1 34.1 34.5 36.2 Goods imports (percent of GDP) 51.4 45.9 53.3 54.6 54.9 57.2 Net services exports (percent of GDP) 7.9 4.4 6.9 7.6 7.8 8.4 Trade balance (percent of GDP) -14.7 -14.0 -12.3 -12.8 -12.5 -12.6 Net remittance inflows (percent of GDP) 8.5 7.4 8.2 7.7 7.4 7.6 Current account balance (percent of GDP) -2.9 -3.9 -2.3 -3.2 -3.0 -2.6 Net foreign direct investment inflows (percent of GDP) 1.5 1.7 2.1 2.0 1.9 2.0 External debt (percent of GDP) 65.6 70.7 65.4 60.3 58.1 58.7 Real private credit growth (percent, period average) 5.2 1.3 -0.3 - - - Nonperforming loans (percent of gross loans, end of period) 7.4 6.1 5.8 - - - Unemployment rate (percent, period average) 15.7 15.9 17.4 - - - Youth unemployment rate (percent, period average) 33.8 36.6 38.2 - - - Labor force participation rate (percent, period average) 42.1 47.7 48.0 - - - GDP per capita, PPP (current international $) 13,775 13,424 14,110 14,710 15,260 15,800 Sources: Country authorities, World Bank estimates and projections. Bosnia and Herzegovina  |  77 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Kosovo • Kosovo’s economy experienced a full recovery in 2021, supported by private consumption and record export growth. • Inflation intensified by the second half of 2021, driven by record increases in import prices. • Against a strong rebound in revenue, the fiscal balance improved and public debt growth decelerated. • Recent external challenges have significanlty increased inflationary risks to the short-term outlook, with growth expected to decelerate in 2022 due to the spillover effects from the war in Ukraine. Recent Economic Developments On the production side, services provided the highest contribution, reflecting the increase in Kosovo’s economy experienced a stronger- consumption and service exports. Industrial than-expected recovery in 2021. Real output activity also added to growth driven, in part, grew5 by a record 12.1 percent for the first three by higher investment in response to stronger quarters of 2021, driven by strong domestic export demand. Agriculture, in contrast, and external demand. Economic growth for subtracted from growth on account of higher the year stood at preliminary 9.1 percent. From input prices and worse weather conditions. the second quarter of 2021, an accelerated vaccination rollout has taken place, which Labor formalization advanced, but helped remove mobility restrictions and information on labor market outcomes in bolstered economic activity. The ongoing 2021 remains limited. Official employment energy crisis reached Kosovo in late 2021, in the private and public sectors rose close to however, bringing nickel exports to a halt and 10 percent, on average, in 2021, compared to highlighting the country’s vulnerability from the year before, according to the Kosovo Tax outdated energy production capacity and high Administration. At the same time, registered import prices. jobseekers dropped by almost a third in 2021 compared to the year before, but their level still Consumption and export growth led the remains 10 percent higher than in 2019. The recovery. Private consumption grew robustly, latest available Labor Force Survey data of Q1 supported by restored consumer confidence and 2021 show that less than a third of working- relaxed mobility restrictions, double-digit credit age (15–65) Kosovars were working. This was, expansion, higher remittances, and significant however, before the recovery was in full swing. fiscal stimuli. Private investment also added to growth, spurred in part by credit expansion Heightened inflationary pressures but also higher real estate FDI inflows. A very accompanied the recovery. Consumer price high contribution from a strong rebound in inflation, driven primarily by higher import diaspora-related exports of travel services and prices, surged to 3.4 percent in 2021, from a record increase in goods exports was offset 0.2 percent a year ago. Consumer prices started by an equally substantial increase in imports. increasing by more than 2 percent from July 5 All comparisons are year on year unless otherwise inidicated. 78  | Kosovo STEERING THROUGH CRISES 2021, peaking at above 6 percent in December The fiscal balance improved significantly and rising to 7.5 percent in February 2022. Food in 2021. The fiscal deficit dropped from and transport prices in February increased by 7.6 percent in 2020 to 1.4 percent of GDP 10.5 and 22.6 percent, respectively. Averaging in 2021, supported by higher tax revenues 11.1 percent, import price inflation intensified and sluggish public investment. Tax revenues from the second quarter of the year onward, jumped by 29 percent, driven by a rebound reaching 14.7 percent and 19.7 percent in economic activity and imports, higher during the third and fourth quarter of the inflation, and a tighter labor market. Current year, respectively. The increase in the fourth spending, in the meantime, grew 7 percent in quarter was driven by higher international nominal terms. The government implemented prices for commodities and manufactured a sizable fiscal stimulus program of 3.2 percent goods. In response, production, construction, of GDP, which included targeted private sector and agricultural input prices recorded increases and social transfers, but also universal child throughout the year. allowances and additional maternity benefits. Public capital expenditures increased in Export growth experienced record highs, nominal terms but remained subdued relative yet the current account deficit (CAD) to output, at 5.5 percent of GDP, and just deteriorated because of a corresponding above three-fourths of the capital budget. As a growth in imports. Merchandise exports result of the drop in the fiscal deficit, public soared by almost 70 percent driven by exports of and publicly guaranteed debt, according to manufactured goods rather than the traditional, the preliminary data, has remained broadly lower-value-added base metal exports. unchanged at 22.5 percent of GDP at end- Meanwhile, imports also grew by almost 2021, compared to the previous year. 50 percent from the year before, reflecting the high import content of domestic demand and The financial market remains stable. Credit exports. Driven by a stronger-than-expected increased by 15.5 percent during 2021, with increase in diaspora visits to Kosovo, exports of household loans increasing by 18.6 percent and services more than doubled in 2021, exceeding corporate loans by 13.6 percent by year end. The 2019 levels by 22 percent. Factor incomes credit interest rate marginally decreased from also rose significantly, primarily reflecting a 6 percent in December 2020 to 5.8 percent in 26 percent increase in net remittance inflows. December 2021. Deposits experienced double- Nevertheless, the CAD deteriorated from digit growth, increasing by 12.4 percent 7 percent in 2020 to 9.1 percent of GDP in in 2021. Capital adequacy and liquidity 2021. Almost half of the CAD was financed by remained above regulatory requirements, while net non-debt-creating FDI, primarily through nonperforming loans amounted to 2.3 percent equity, while revinvested earnings dropped of total loans in December 2021. The Kosovo sharply against higher dividend payouts. Loans Credit Guarantee Fund continued to expand and trade credit to the private sector financed its coverage, including through government- the rest of the CAD, while public debt increases subsidized guarantee fees, and bolstered credit financed less than one-tenth of the CAD in growth. 2021. Kosovo  |  79 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Outlook and Risks European Union, affecting remittances, travel exports, and real estate FDI. Growth in 2022 is projected to decelerate to 3.9 percent, affected by the economic Kosovo is a net importer of food and energy, consequences of the Russian invasion and the war in Ukraine is amplifying and the war in Ukraine and associated inflationary pressures. Under the baseline sanctions. Inflationary pressures will reduce scenario, headline inflation is expected to real disposable income and impact consumer accelerate to 5.4 percent in 2022. Price confidence. Nevertheless, business investment levels are projected to remain elevated but to is expected to drive growth in 2022 due to gradually normalize under the assumption of the continuation of ongoing construction subsiding global inflationary pressures from projects and higher manufacturing investment the second part of the year. While direct linked to the recent surge in manufacturing trade links with Russia and Ukraine are exports. Public investment is expected to be limited and concentrated on base metals and solid, financed through concessional financing mineral products, the indirect impact from from international financial institutions and international commoditiy prices, including improved execution against more efficient food commodities, is already affecting inflation. procurement. Net exports will remain negative, Kosovo imports an average of 40 percent of its as imports rise to meet the increase in domestic wheat needs and has an even higher import demand and to respond to higher private dependence on select agricultural products. investment. As a result, the CAD is projected Bans on exports of agricultural products to exceed 9 percent of GDP in 2022. including from Serbia could significantly aggravate inflationary pressures. Kosovo also Over the medium term, the outlook remains imports fuel and electricity, especially during positive, but downside risks are elevated. the winter season, and the persistency of high Growth is projected to average above 4 percent, electricity prices could exacerbate the ongoing but the persistence of scarring from the ongoing energy crisis. At the same time, exports of base energy crisis and global inflationary pressures metals could benefit from the global shortages may deteriorate the outlook. The ongoing triggered by the war in Ukraine and accelerate domestic energy crisis is a pressing concern. export volumes and prices. While the increase in energy consumption is significant, outdated domestic electricity The fiscal deficit in expected to widen in production capacity can result in supply 2022. Revenues are expected to decelerate disruptions and a large demand for electricity but remain strong in 2022, with tax revenues imports. Such exposure to unplanned imports increasing by close to 10 percent compared to of electricity at spiraling import prices remains 2021. Robust revenue performance is based high, and could impact both consumer and on the contribution from inflation and a full- producer prices alike as well as government year effect of formalization gains. Expenditure expenditure. At the same time, a prolonged growth is expected to outpace revenues due impact of the war in Ukraine could more to a strong rebound in capital expenditure, significantly impact real disposable income and increasing by almost a third, as well as higher incomes of the diaspora mainly living in the current spending, with full-year effects of new 80  | Kosovo STEERING THROUGH CRISES social benefits programs. Furthermore, in response to the energy crisis and the revision of energy tariffs, the government has already committed close to 1.2 percent of GDP in electricity subsidies for households. As a result, the fiscal deficit is expected to increase from 1.4 percent to 2.2 percent of GDP. Over the medium term, the deficit is expected to remain below 3 percent of GDP, and in line with the fiscal rule, which the authorities are committed to formally reimpose from 2023. Total public and publicly guaranteed debt is expected to reach 24.3 percent of GDP in 2022, with an increase in concessional external debt and slower accumulation of domestic debt. Financial sector performance is expected to support growth. Exposure to Ukraine and Russia is limited, but costs of financing are set to grow. Further capitalization of the Kosovo Credit Guarantee Fund is expected to enhance access to credit in 2022. Credit growth is expected to remain strong given the significant scope for credit deepening. However, global finance tightening and inflationary pressures are likely to exert upward pressures on interest rates. Maintaining fiscal space to respond to the changing macroeconomic environment remains crucial. This calls for particular caution toward policies that may have high long-term fiscal costs, such as public sector compensation reform. Over the medium term, there is a pressing need to use the momentum for higher exports and focus policies on enhancing competitiveness, including by tackling constraints to higher productivity growth and human capital investment. Kosovo  |  81 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Economic activity fully recovered. Exports experienced record growth. Contributions to growth, percentage points Exports of goods and services, million euros 15 2,000 12 1,800 9 1,600 6 1,400 3 1,200 0 1,000 -3 800 600 -6 400 -9 200 -12 0 -15 2019 2020 2021 2019 2020 2021 2019 2020 2021p 2022f Exports of services Exports of goods J Consumption J Investment J Exports J Imports ▬ Growth Sources: Kosovo Statistics Agency; World Bank staff calculations. Source: Central Bank of Kosovo; World Bank staff calculations. Strong revenue performance narrowed the Inflation increased in 2021 and early 2022. deficit. Percent of GDP CPI inflation, percent 35 8 7 30 6 25 5 20 4 3 15 2 10 7.6 1 0 5 2.9 1.4 2.2 -1 0 19 19 19 9 20 20 20 0 21 21 21 1 22 /2 /1 /2 1/ 4/ 7/ 1/ 4/ 7/ 1/ 1/ 4/ 7/ 2019 2020 2021p 2022f 10 10 10 J Public revenues J Public expenditures ▬ Budget deficit, rhs Sources: Ministry of Finance; World Bank staff calculations. Source: Kosovo Statistics Agency. Remittances and real estate FDI spurred the Credit experienced double-digit growth. recovery. Remittances and real estate FDI inflows, million euros Credit growth, percent 1,600 20 1,400 18 1,200 16 1,000 14 12 800 10 600 8 400 6 200 4 0 19 19 19 9 20 20 20 0 21 21 21 1 22 /2 /1 /2 1/ 4/ 7/ 1/ 4/ 7/ 1/ 1/ 4/ 7/ 2018 2019 2020 2021p 10 10 10 J Inflow of remittances J Inflow of FDI in real estate activities ▬ Total loans ▬ Loans to nonfinancial corporations ▬ Loans to households Source: Central Bank of Kosovo. Source: Central Bank of Kosovo. 82  | Kosovo STEERING THROUGH CRISES KOSOVO 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) 4.8 -5.3 9.1 3.9 4.3 4.2 Composition (percentage points): Consumption 6.2 2.2 6.0 1.7 2.3 1.8 Investment -1.1 -2.4 3.1 2.7 2.4 2.5 Net exports -0.3 -5.1 0.0 -0.5 -0.4 -0.1 Exports 2.2 -8.4 15.0 1.7 1.9 2.1 Imports (-) 2.5 -3.3 15.0 2.1 2.3 2.2 Consumer price inflation (percent, period average) 2.7 0.2 3.4 5.4 1.6 2.2 Public revenues (percent of GDP) 26.8 25.4 28.7 28.4 28.2 28.2 Public expenditures (percent of GDP) 29.7 33.0 30.1 30.6 30.9 30.7 Of which: Wage bill (percent of GDP) 8.7 9.8 8.8 8.5 8.9 8.8 Social benefits (percent of GDP) 6.3 7.7 7.4 7.2 7.0 6.6 Capital expenditures (percent of GDP) 7.5 5.6 5.5 6.5 6.8 7.0 Fiscal balance (percent of GDP) -2.9 -7.6 -1.4 -2.2 -2.6 -2.5 Primary fiscal balance (percent of GDP) -2.6 -7.2 -1.0 -1.7 -2.2 -2.2 Public debt (percent of GDP) 17.0 22.0 22.1 24.0 25.3 26.9 Public and publicly guaranteed debt (percent of GDP) 17.6 22.4 22.5 24.3 25.4 27.0 Of which: External (percent of GDP) 5.8 7.8 7.6 9.2 9.9 10.6 Goods exports (percent of GDP) 5.6 6.9 9.9 9.8 9.8 9.9 Goods imports (percent of GDP) 45.8 44.2 56.7 55.2 55.0 54.7 Net services exports (percent of GDP) 13.1 5.7 14.2 12.6 13.5 14.4 Trade balance (percent of GDP) -27.1 -31.6 -32.7 -32.9 -31.7 -30.4 Net remittance inflows (percent of GDP) 11.6 13.8 15.7 14.7 14.1 13.9 Current account balance (percent of GDP) -5.6 -7.0 -9.1 -9.7 -9.0 -8.0 Net foreign direct investment inflows (percent of GDP) 2.7 4.2 4.2 4.2 4.0 4.0 External debt (percent of GDP) 31.2 37.2 37.3 - - - Real private credit growth (percent, period average) 7.8 7.6 7.5 - - - Nonperforming loans (percent of gross loans, end of period) 1.9 2.5 2.3 - - - Unemployment rate (percent, period average) 25.7 24.5 - - - - Youth unemployment rate (percent, period average) 49.4 49.4 - - - - Labor force participation rate (percent, period average) 40.5 37.8 - - - - GDP per capita (US$) 4,416 4,350 5,058 5,281 5,657 5,967 Poverty rate (percent of population) 21.1 23.2 19.4 17.6 15.8 14.4 Source: Country authorities, World Bank estimates and projections. Note: Poverty rate calculations based on ECAPOV harmonization using 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$5.5/day per person in revised 2011 purchasing power parity. e = estimate; ECAPOV = ECA Poverty, a harmonization effort for Eastern Europe and Central Asia countries based on available household budget surveys and Living Standards Measurement Surveys; f = forecast; HBS = household budget surveys; SILC = Survey on Income and Living Conditions.; - = not available. Kosovo  |  83 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Montenegro • Montenegro’s economic recovery in 2021 was stronger than expected, supported by a rebound in tourism; in parallel, inflation surged to 6.7 percent in February 2022, a 10-year high. • The labor market responded to economic recovery and returned to pre-pandemic trends, with unemployment dropping to close to 15 percent. • The fiscal deficit fell from 11 percent of GDP in 2020 to 2 percent in 2021. • Montenegro adopted a landmark reform program, Europe Now, which carries many opportunities but also significant fiscal risks. • The outbreak of war in Ukraine has worsened the otherwise positive outlook for Montenegro, with risks tilted to the downside. Recent Economic Developments compared to a year earlier, supporting retail and wholesale trade, which expanded by 17 percent The rebound in tourism paved the way for and 24 percent, respectively. Industrial a robust economic recovery in 2021. The production strengthened by 4.9 percent, driven economy bounced back strongly, recording by increases in both manufacturing and energy a preliminary growth rate of 12.4 percent, production, and despite a decline in the mining but real GDP still remained below the 2019 sector. Meanwhile, construction declined level. Reviving tourism, exports, and private by 5 percent, as did the number of issued consumption have led growth, with tourism construction permits, which could be a signal revenues reaching 70 percent of their 2019 level of a continued decline in the construction from just 13 percent in 2020. Exports added sector. 25.5 percentage points (pp) to growth. Tourism, together with the recovery in employment and Job creation gained momentum in the third an increase in household lending, supported quarter of 2021. Labor force survey (LFS)6 the strong private consumption rebound, data show an increase in employment in the which added 4.2 pp to growth. Government third quarter by 21 percent compared to the consumption added another 0.3 pp. Delays in first quarter (Q1), which remained at similar public investments, higher costs of materials, level in the fourth quarter (Q4). Such job and continued supply-chain disruptions slowed creation equally benefited male and female gross fixed capital investments, which dragged employees. The activity rate rose to 54.4 percent growth by 4.8 pp, also adversely impacting the in Q4 from 47.6 percent in Q1, while at the pace of imports. same time the unemployment rate fell to 15.4 percent from 19.4 percent. The revised In contrast to the robust rebound in services, administrative data show steady employment agriculture and construction contracted. gains in the last quarter of 2021 across all In 2021, the number of overnight stays sectors, with employment starting to rise above of international tourists more than tripled its pre-pandemic level in October 2021. The 6 The change in the 2021 LFS methodology does not allow for comparisons with previous years’ LFS data. 84  | Montenegro STEERING THROUGH CRISES government phased out wage subsidies in July published in September 2021 and indicated 2021. The Parliament adopted an increase in that the banking sector was in a good position the net monthly minimum wage from €250 prior to the crisis, although there may have to €450, as part of the Europe Now reform been a deterioration in asset quality that will be program, effective January 1, 2022. visible after all support measures are withdrawn. Global inflationary pressures are accelerating Strong net service exports and remittances domestic inflation, given the unilateral significantly narrowed the current account euroization. In 2021, inflation averaged deficit. In 2021, the current account deficit 2.4 percent, with year-end inflation totaling narrowed to 9.2 percent of GDP, the lowest since 4.6 percent and rising further to 6.7 percent 2004. With a growth rate of 95 percent, exports (y/y) in February 2022, a 10-year high. The of goods and services outpaced imports, which increase in inflation was led by rising food, increased 21 percent, narrowing the trade and beverage, and transportation prices. Real services deficit to 19.6 percent of GDP. Strong disposable income was nevertheless largely net exports were supported by a strong recovery preserved through the increase in disposable of tourism and transport services, metals, and incomes due to the Europe Now reform, electricity exports, but also slower imports which resulted in the average net monthly growth due to declining investments. Net wage increasing from €537 in December primary and secondary incomes have further 2021 to €686 in January 2022, an increase of reduced the current account deficit, primarily 22.7 percent y/y in real terms. due to strong net remittances, which increased by 35 percent. The current account deficit The financial sector has remained robust so was entirely financed by net foreign direct far. In February 2022, outstanding loans were investment, which amounted to 11.2 percent up by 6.9 percent, driven by lending to the of GDP. In January 2022, international reserves private sector and non-resident lending. At the stood at €1.7 billion, covering eight months of same time, deposits were up by 25.6 percent, merchandise imports. reaching record levels, led by increases in private sector and household deposits. The lending- The fiscal deficit fell from 11 percent of to-deposits ratio declined to 79 percent, its GDP in 2020 to 2 percent in 2021. The fiscal lowest level ever. In 2021, new loans surged consolidation was supported by a rebound by 23 percent, though that remained below in revenues, under-execution of capital the 2019 level. The December average capital expenditures, and a reduction in current adequacy ratio was a healthy 18.5 percent, spending. The latter occurred despite Covid- well above the regulatory minimum, while related support provided in the first half of the nonperforming loans increased to 6.8 percent year. Central government revenues increased of total loans from 5.9 percent in December by 16.5 percent, driven by the VAT and last year. The Central Bank has commissioned excises, and surpassed the revenues collected an Asset Quality Review to identify stressed in 2019 by 1.3 percent. At the same time, assets and make necessary provisions in central government expenditures declined by banks’ balance sheets. After delays due to 2.3 percent, primarily due to lower capital the pandemic, the Asset Quality Review was spending by 9 percent, but also lower spending Montenegro  |  85 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 on goods and services, which declined by contributions. These include increases in excises 16 percent. The Parliament adopted the 2022 on tobacco, alcohol, and sugary beverages; and budget with the fiscal deficit at 5 percent introduction of excises on sugary products of GDP, as the government plans to ramp and single-use plastic. The Parliament also up capital spending and has widened social maintained the reduced VAT rate of 7 percent transfers. The Parliament introduced benefits for the hospitality industry, introduced as a for all children until age 18, reintroduced crisis mitigation measure. Failure to adopt mothers’ benefits for former beneficiaries, and compensating revenue measures is likely to increased minimum pensions to €200, further result in a wider-than-planned fiscal deficit worsening pension system sustainability and in 2022, with possible adverse consequences equity. for the following years. In addition, due to the pension indexation formula, spending Public debt declined to 85 percent of GDP on pensions is expected to increase strongly in 2021 from 105 percent in 2020. The 2021 in 2023, further widening the fiscal deficit. gross financing needs were largely covered Finally, administrative capacity challenges are by the €750 million Eurobond placed in a risk to the successful implementation of the 2020. Net debt in 2021 was reduced by over reform. €330 million, including a repayment of €227 in Eurobonds in March 2021. The central In February 2022, there was a vote of no government fiscal balance was positive in confidence in the government, and a new four months over the last year, which further government is yet to be formed. A turbulent supported the buildup of government deposits, political environment is adding to already high amounting to 9.5 percent of GDP in 2021, uncertainty, putting at risk, or slowing the which will be financing a significant share of implementation of structural reforms (such as financing needs in 2022. public administration reform and tax, pension, and healthcare reforms). Montenegro adopted a landmark reform program, Europe Now, which carries many opportunities, but also risks. The Outlook and Risks key elements of the reform program are the abolition of healthcare contributions, The outlook is fragile in an environment introduction of a personal income allowance of increasing uncertainty. The outbreak for wages up to €700, progressive personal and of the war in Ukraine and the associated corporate income taxation, and an increase in developments have significantly worsened the net monthly minimum wage. The program the outlook for Montenegro, the economy of has the potential to reduce inequalities and which is now expected to grow by 3.6 percent increase formal employment and growth over in 2022, down from an estimated 5.9 percent the medium term, especially if complemented before the start of the war. The main direct by additional structural reforms, but also transmission channel of the war to Montenegro’s poses fiscal risks. The Parliament rejected economy is tourism. In 2021, tourists from several measures of the program to offset the Russia, Ukraine, and Belarus accounted for loss in revenues from the abolished health 22 percent of total overnight stays. Assuming a 86  | Montenegro STEERING THROUGH CRISES continuation of the strong recovery of tourism be fiscally vigilant as the 2018 Eurobond of receipts from other countries (to 90 percent €500 million comes due in 2025. Given the of their 2019 level) and a decline of overnight incomplete implementation of the Europe Now stays from Russia, Ukraine, and Belarus by revenue measures, further fiscal adjustments 75 percent, total tourism receipts remain at are needed to avoid a significant increase in the levels similar to those in 2021. The expected fiscal deficit in 2022 and enable the return to decline in tourism due to the war slows exports primary fiscal surpluses over the medium term, and private consumption. Consumption is which is critical for debt reduction. expected to remain strong, however, due to the positive effects of higher disposable incomes, The current account deficit is expected to the employment recovery, and higher-than- widen and remain at around 12 percent of expected inflation. Investments are expected GDP over the medium term. A pause in the to pick up as the works on the highway tourism recovery in 2022 and an increase in completion are resumed and other capital commodity prices will results in a wider current spending increases, while in parallel, private account deficit. At the same time, merchandise investments in the tourism and energy sectors exports, particularly exports of aluminum continue, but at a slower pace. and electricity, will partly offset the negative effects. In January 2022 alone, Montenegro Inflation is expected to remain elevated. exported 25 percent and 40 percent of the total Global inflationary pressures and, to a lesser value of aluminum and electricity exported extent, domestic pressures stemming from an in 2021, respectively. Assuming a resumption increase in wages after implementation of the in the tourism recovery in 2023 and a further Europe Now program, will push inflation to increase in energy exports, exports are expected an estimated 5 percent in 2022. Price spikes of to recover. At the same time, the announced key commodities and food will directly impact investments in these two sectors will keep households, though the impact will be offset import levels elevated at around 64 percent of by the increase in wages for formally employed GDP in 2023–24. Net primary and secondary through the Europe Now program. However, incomes are estimated to partially offset the more adverse impacts on the tourism sector trade deficit, assuming net remittances remain pose a risk to household budgets. at 90 percent of their levels observed in 2020– 21. Net foreign direct investment is expected Utmost fiscal prudence is needed to return to decline to 8 percent of GDP in 2022 but public debt to Montenegro’s fiscal rule of rebound to 8.7 percent in 2023 and continue 60 percent of GDP. Contrary to previous plans, financing the current account deficit. the fiscal balance is now not expected to turn into a surplus until 2025, and a primary surplus The deteriorating environment poses is likely only in 2024. Public debt is expected further significant risks to the outlook. Risks to decline from 77 percent of GDP in 2022 to stem from both the external and domestic 73 percent of GDP in 2024. With the expected environments. A prolonged war in Ukraine monetary tightening in the United States and and related sanctions on Russia directly weigh global geopolitical uncertainties weighing on on Montenegro’s recovery through reduced the risk appetite of investors, Montenegro must tourism and investments, which could further Montenegro  |  87 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 reduce growth. In addition, the impact of the conflict on Montenegro’s key trading partners (namely, the Western Balkans and the EU) would have negative spillovers on growth, but also remittances. Risks also come from monetary tightening, which would translate into more expensive external financing. Political instability is the main domestic risk. Other risks stem from the administrative capacity challenges to implement the Europe Now program and the impact the program will have on the fiscal deficit in the medium term, which may risk derailing medium-term debt reduction plans. Acceleration of structural reforms (including pension reforms) and fiscal prudence are needed to mitigate increasing risks and uncertainties. 88  | Montenegro STEERING THROUGH CRISES The 2021 recovery was robust… …largely driven by reviving tourism. Real GDP growth, percent International tourists’ overnight stays, in thousands 16 1,000 12 900 800 8 700 4 600 0 500 -4 400 300 -8 200 -12 100 -16 0 p 10 20 1 12 13 14 20 5 16 20 7 18 20 9 20 6 20 7 08 09 20 1 2 3 4 5 6 7 8 9 10 11 12 21 1 1 0 1 1 0 20 20 20 20 20 20 20 20 20 20 J 2015–19 average J 2020 J 2021 Sources: MONSTAT data; World Bank staff calculations. Sources: MONSTAT; World Bank staff calculations. The labor market rebounded strongly... ... and inflation continued surging. Administrative data, thousands, Jan 2016–Jan 2022 Administrative data, Jan 2017–Feb 2022 230 70 6 650 220 600 60 5 550 210 4 500 50 450 200 3 400 190 40 350 2 180 30 300 1 250 170 200 20 160 0 150 10 -1 100 150 50 140 0 -2 0 16 16 17 17 18 18 19 19 20 20 21 21 22 17 17 18 8 19 19 20 0 21 1 22 2 1 2 7/ 7/ 1/ 1/ 1/ 1/ 7/ 7/ 1/ 1/ 1/ 1/ 7/ 1/ 1/ 1/ 7/ 7/ 7/ 7/ 1/ 1/ 7/ 7/ ▬ Employment, lhs ▬ Employment_tc, lhs ▬ CPI (percent), lhs ▬ Real net wage (EUR 2015), rhs ▬ Unemployment, rhs ▬ Unemployment_tc, rhs Source: MONSTAT data. tc=trend cycle. Source: MONSTAT data; World Bank staff calculations. Outstanding loans have been increasing. The fiscal deficit is widening again. Outstanding loans, Jan 2012–Jan 2022, in millions 2015–22, percent of GDP 4.0 60 0 3.5 50 -2 3.0 2.5 40 -4 2.0 30 -6 1.5 20 -8 1.0 0.5 10 -10 0 0 -12 p 17 17 18 18 19 9 20 0 21 21 22 f 15 16 17 18 19 20 22 21 1 2 7/ 1/ 1/ 7/ 1/ 1/ 1/ 7/ 7/ 1/ 7/ 20 20 20 20 20 20 20 20 J Private corporate J Government J Households J Total revenues and grants J Total expenditure and net lending J Financial sector J Other ▬ Accrual deficit, rhs Sources: Central Bank; World Bank staff calculations. Sources: Ministry of Finance; World Bank staff calculations. Montenegro  |  89 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 MONTENEGRO 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) 4.1 -15.3 12.4 3.6 4.7 3.7 Composition (percentage points): Consumption 2.9 -3.9 4.5 3.8 3.3 2.6 Investment 0.9 -5.9 -5.5 1.9 2.5 2.8 Net exports 0.3 -5.5 13.4 -2.2 -1.1 -1.7 Exports 2.9 -24.2 25.5 1.1 3.7 3.0 Imports (-) 2.6 -18.7 12.0 3.3 4.9 4.7 Consumer price inflation (percent, period average) 0.4 -0.3 2.4 5.0 2.3 1.6 Public revenues (percent of GDP) 43.3 44.4 43.6 41.1 40.9 40.7 Public expenditures (percent of GDP) 46.0 55.5 45.6 46.3 43.9 42.4 Of which: Wage bill (percent of GDP) 11.0 13.5 12.2 11.6 11.0 10.6 Social benefits (percent of GDP) 11.2 13.4 11.6 12.5 13.2 12.6 Capital expenditures (percent of GDP) 8.7 7.5 5.2 6.6 5.8 6.2 Fiscal balance (percent of GDP) -2.7 -11.0 -2.0 -5.2 -3.0 -1.7 Primary fiscal balance (percent of GDP) -0.5 -8.3 0.4 -3.4 -1.4 -0.2 Public debt (percent of GDP) 76.5 105.3 84.9 77.4 75.2 73.1 Public and publicly guaranteed debt (percent of GDP) 80.0 108.7 87.7 80.1 77.6 75.4 Of which: External (percent of GDP) 68.1 97.3 80.0 73.6 69.1 67.1 Goods exports (percent of GDP) 9.4 9.8 10.7 11.5 11.1 11.1 Goods imports (percent of GDP) 51.1 49.0 49.7 50.5 50.7 51.2 Net services exports (percent of GDP) 20.6 4.2 19.4 18.3 19.9 20.7 Trade and services balance (percent of GDP) -21.1 -35.0 -19.6 -20.7 -19.7 -19.4 Net remittance inflows (percent of GDP) 4.0 5.3 6.1 5.0 4.6 4.4 Current account balance (percent of GDP) -14.3 -26.1 -9.2 -12.6 -12.1 -12.0 Net foreign direct investment inflows (percent of GDP) 6.2 11.2 11.2 8.1 8.7 8.7 External debt (percent of GDP) 169.0 224.1 199.0 194.8 190.9 188.4 Real private credit growth (percent, period average) 5.5 6.4 -0.2 - - - Nonperforming loans (percent of gross loans, end of period) 5.1 5.9 6.8 - - - Unemployment rate (percent, period average) 15.1 17.9 16.6 - - - Youth unemployment rate (percent, period average) 25.2 36.0 37.1 - - - Labor force participation rate (percent, period average) 57.4 53.3 50.9 - - - GDP per capita, PPP (current international $) 23,097 20,030 22,128 23,760 25,276 26,668 Poverty rate (percent of population) 15.6 19.9 16.2 15.6 14.8 - Sources: Country authorities, World Bank estimates and projections. Note: 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 $5.5/day per person in revised 2011 PPPs. 90  | Montenegro STEERING THROUGH CRISES North Macedonia • As the economy gradually rebounded from the pandemic-induced recession, the energy crisis and the war in Ukraine brought new challenges. The Covid-19 support needs to be replaced with targeted fiscal support to the most energy vulnerable households and firms as public debt increases further. • Consumer price increase accelerated from late 2021, fueled by energy and food prices, while a double-digit minimum wage increase would add to inflationary pressures from March 2022. • The labor market is slowly improving, but high youth unemployment calls for policy intervention. • The short-term outlook deteriorated: the 2022 growth projection was reduced to 2.7 percent, while downside risks intensified. Over the medium term, the outlook remains positive, subject to setting public finances back on a sustainable path, accelerating human capital development, a green transition, and competitiveness reforms. Recent Economic Developments It recovered slightly with 3.8 percent growth on average in the first two months of 2022. Economic growth rebounded to 4 percent Tourism improved as movement restrictions in 2021, following a deep contraction in waned, but the pace slowed by January 2022 2020. After falling by 6.1 percent in 2020, and tourism arrivals have not yet reached the growth in 2021 was driven by a surge in pent- pre-pandemic level. up private consumption, amidst still strong government consumption, and a growing The labor market witnessed a very slow investment contribution. Exports and imports improvement despite government support. bounced back, but the trade balance worsened. The unemployment rate decreased to On the production side, growth was driven by 15.2 percent in Q4 2021, but not due to a rise services (trade, ICT, transport, and tourism), in the employment rate, which stagnated at as industrial production struggled with supply- 47.3 percent, but on account of a lower activity chain interruptions and reduced export orders. rate (down by 0.1 pp y/y to 55.7 percent in Construction saw a further decline. Q4 2021). The activity rate is still hovering below the pre-pandemic level. Although the The end of 2021 saw a slowdown in growth, employment rate rose 0.7 pp from the low in with a modest recovery at the beginning of Q3 2020, at 47.3 percent it remains below the 2022. Real growth declined to 2.3 percent in pre-crisis peak of 48.1 percent, due to a fall in Q4 2021. Manufacturing recorded a 5.2 percent private sector employment. At the same time, drop y/y in Q4 2021, with energy production unemployment decreased to a historically low and mining slightly cushioning the blow, but it rate, driven by a drop in female and youth bounced back to 4 percent in February 2022. unemployment. The youth unemployment Agricultural production dropped by 3.6 percent rate, however, at 34.9 percent remains high. in Q4 2021. Meanwhile, real retail trade Per Employment Agency data, the number of growth decelerated to only 1.2 percent y/y in new employment contracts in 2021 increased December 2021 from 15.7 percent in August. by nearly 15 percent, suggesting a recovery North Macedonia  |  91 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 of labor demand. However, there has been a over to North Macedonia, a net food and greater use of fixed-term contracts (58 percent energy importer. The inflation rate averaged of all new employment) as uncertainty about 3.2 percent in 2021, with prices accelerating in the growth recovery still looms. the second half of the year. The producer price index increased by 16.4 percent in January With increased labor demand, wages 2022 and spilled over to inflation that stood continued to steadily grow in 2021. Real at 8.8 percent in March 2022. Inflation is net wage increased by 2.3 percent, led by food also becoming more broad-based, with core and accommodation services, trade, transport, inflation rising to 5.2 percent. Energy prices rose professional services, and ICT. In February 14.4 percent y/y, while food prices increased by 2022, the government increased the minimum 11.7 percent y/y in March 2022 despite the wage by 18.5 percent (to be applied for March government decision to freeze basic foodstuff wage onwards) and introduced the mandatory prices, and agricultural inputs, including annual indexation of the minimum wage with fertilizers. In March 2022, the government consumer prices and average national wage adopted several additional measures to alleviate growth. The rise in labor costs prompted the inflationary pressures: it reduced the VAT the government to subsequently provide on petrol and gas to 10 percent, reduced excises temporary compensation to firms through the on oil derivates if prices hit a threshold, and contribution subsidy support program. exempted the basic foodstuff and imported energy from VAT. As the merchandise trade deficit deteriorated, the external imbalance worsened, too. The Monetary policy remained accommodative current account deficit slightly worsened throughout 2021 and in early 2022 before to 3.5 percent of GDP in 2021, owing to started tightening in April. The policy rate a deterioration in the trade balance. This is was increased to 1.50 percent, while liquidity in despite a rise in remittances and service exports. the domestic market remains high. Specifically, The merchandise trade deficit widened to the banking sector liquidity ratio stood at 20.2 percent of GDP (from 17 percent a year 23 percent in Q4 2021, while the capital ago), as energy balance worsened and firms in adequacy ratio increased to 17.3 percent. the car supply chain struggled with declining Credit growth to the private sector continued orders, while the services balance improved to at an accelerated pace of 8 percent, led by 4.3 percent of GDP, boosted by a recovery in foreign exchange (FX)-denominated mortgage tourism. At the end of Q3 2021, gross external lending, and accompanied by a surge in debt stood at 84.1 percent of GDP, up from real estate prices. The non-performing loans 80.3 percent at end-2020. The public sector ratio dropped to 3.1 percent in Q4 2021, contributed most to the rise. but banks’ expectations remain subdued, according to the Autumn 2021 EIB CESEE Global supply shortages and surging 7 Bank Lending Survey. On April 1, 2022 the demand resulted in rising energy and food National Bank reduced the reserve requirement prices that reached a decade high, and spilled ratio for deposits in domestic currency from 7 European Investment Bank Central, Eastern and South-Eastern Europe Bank Lending Survey. 92  |  North Macedonia STEERING THROUGH CRISES 8 to 6.5 percent and increased the reserve Public and publicly guaranteed debt requirement ratio for deposits in foreign stabilized in 2021. Reaching 60.8 percent currency from 15 to 16.5 percent in order to of GDP, public and publicly guaranteed debt stimulate domestic currency savings. declined by 0.2 percent of GDP in a year but remained elevated at 11.6 percentage points of The fiscal deficit declined in 2021 led by GDP above the pre-crisis 2019 level. Payment buoyant revenue performance that continued arrears increased significantly to 3.3 percent in early 2022. The fiscal deficit narrowed to of GDP by year-end calling for strengthening 5.4 percent (or 5.8 percent including the State fiscal discipline and clearing the arrears in the Enterprise for Roads) in 2021, below the latest short term. This may limit the fiscal space for budget rebalance target. Tax revenues increased crisis response going forward. by 1.8 pp of GDP, driven by VAT collection as consumption surged. Capital spending increased by 1 pp of GDP and its execution rate Outlook and Risks reached 80 percent compared to the 2021 plan, indicating improved performance. As crisis- Economic growth is expected to decelerate to related support decelerated, current spending 2.7 percent in 2022, with real GDP reaching declined. Yet, expenditure arrears increased by the pre-pandemic level by mid-year. The 0.6 pp to 3.3 percent of GDP on account of baseline scenario rests on the assumption that overdue payments in the health sector, state the acute phase of the crisis eases in Q2 2022 enterprises, and local governments, raising the even if effects of sanctions persist through 2022 deficit on an accrual basis to 6 percent of GDP. and even into 2023. Energy, agriculture, and In November 2021, the government declared car-supply manufacturing sectors will be more an energy crisis, temporarily taking over the affected than the others. However, the Ukraine private heating company to avoid outages,8 war, if prolonged, would further reduce and transferred around 0.7 percent of GDP external demand, increase key commodity and to cover the loses of energy companies. A new energy prices, hamper mobility, and result in support package was announced in early 2022 investment delays. This scenario would result in that includes reduction in VAT and excises for even lower growth and fiscal revenues, as well as electricity, gas, and oil derivatives, liquidity rising requests for fiscal support and a surge in credit lines for firms through the Development financing costs. Bank, social benefits to pensioners and vulnerable households, an exemption from The fiscal deficit is expected to remain high in VAT for basic foodstuff and importers of 2022, due to the continued support to firms and electricity, heat, cooling energy and gas, energy households to alleviate the impact of the energy efficiency measures. The overall package for and war-related crises. It will very gradually 2022 amounts to 3.2 percent of GDP which subside only by 2024, leaving the public debt will require the 2022 budget revision. at above 64 percent of GDP. A delivery of the ambitious Growth Acceleration Plan rests on strengthening the implementation capacity, 8 The Balkan Energy Group company (BEG). North Macedonia  |  93 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 and securing affordable financing, which is targeted support to the domestic economy. getting tighter. In the context of eroded fiscal Structural reform efforts need to be aligned space and rising public debt, the continuous with the green agenda and enable the low- and generous fiscal support, through subsidies, carbon transition and reduced greenhouse gas broad and widening tax exemptions, and emissions. frequent changes of pension policy with sizeable budget implications, is not sustainable and could derail macroeconomic stability going forward. The medium-term outlook remains positive, but risks are largely tilted to the downside and accentuated. Disruptions related to the protracted pandemic shock, the war in Ukraine, prolonged supply chain disruptions, rising minimum wage pressures adding to other inflationary pressures, weak domestic political stability, including the de-facto paralysis in the parliament, and the looming energy crisis continue to weigh on the outlook. Heightened political uncertainty, and delayed EU accession negotiations, amidst an energy and health crisis, may lead to a weaker reform appetite needed to boost potential growth and consolidate public finances. Furthermore, the tightening of global financial conditions may affect financing options and costs for North Macedonia in the near future. On the positive side, delivery of the Growth Acceleration Plan that targets human capital development, the green transition, and digitalization may boost potential growth. In the medium term, the country will need to strengthen the sustainability of public finances and shift its focus to resolving structural challenges, i ncluding low and  declining human capital, weak regulatory frameworks, poor competition policy, judiciary, declining productivity, and rising migration. In addition, the government will need to rethink and rationalize state aid to address fiscal sustainability concerns and provide more 94  |  North Macedonia STEERING THROUGH CRISES The economy is slowly recovering from the …as evidenced by high-frequency indicators. pandemic-induced recession… Percent Trade cycle adjusted, 2011=100 15 180 220 160 200 10 140 180 5 120 160 0 100 140 80 -5 120 60 -10 40 100 -15 20 80 17 17 18 8 19 9 20 20 21 21 7 7 8 8 9 9 0 0 1 1 1 1 -2 -2 -1 -1 -1 -1 -1 -1 7/ -2 -2 1/ 1/ 7/ 1/ 1/ 7/ 7/ 1/ 7/ Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 ▬ Industry_tc ▬ Retail trade_tc ▬ Tourism_tc ▬ Construction_tc, rhs Source: State Statistics Office. Source: State Statistics Office and World Bank staff calculations. The labor market is gradually recovering. Inflationary pressures continue to accumulate. Percent Percent, yearly change 60 20 55 24 50 15 22 45 20 10 40 35 18 5 30 16 0 25 20 14 -5 17 17 18 18 19 19 20 20 21 21 22 7 7 8 8 9 9 0 0 1 1 -2 -2 -1 -1 -1 -1 -1 -1 1/ 7/ -2 -2 1/ 7/ 1/ 7/ 1/ 7/ 1/ 1/ 7/ Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 J Activity rate J Employment rate ▬ Unemployment rate, rhs ▬ CPI total ▬ PPI total Source: State Statistics Office. Source: State Statistics Office. External imbalances widened. Public debt growth stabilized in 2021. Percent of GDP Percent of GDP 30 1 70 1 0 20 60 0 -1 50 -2 10 -1 40 -3 0 -4 30 -5 -2 -10 20 -6 -7 -20 -3 10 -8 -30 0 -9 -4 p p 15 16 17 18 19 14 15 16 17 18 19 20 20 21 21 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 J Goods J Services J Income J Current transfers J Domestic debt J Foreign debt J Guarantees ▬ Fiscal deficit, rhs ▬ Current account balance Source: Central Bank. Source: Ministry of Finance and World Bank staff estimates. North Macedonia  |  95 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 NORTH MACEDONIA 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) 3.9 -6.1 4.0 2.7 3.1 3.2 Composition (percentage points): Consumption 3.1 -2.4 5.0 2.3 2.0 2.5 Investment 3.3 -5.3 2.2 1.5 2.1 2.2 Net exports -2.4 1.7 -3.3 -1.1 -1.0 -1.5 Exports 5.8 -7.4 7.9 5.0 5.1 4.5 Imports (-) 8.2 -9.1 11.2 6.1 6.1 6.0 Consumer price inflation (percent, period average) 0.8 1.2 3.2 5.5 2.0 1.8 Public revenues (percent of GDP) 31.4 30.5 32.3 33.1 33.2 33.5 Public expenditures (percent of GDP) 33.5 38.9 37.7 38.4 38.0 37.2 Of which: Wage bill (percent of GDP) 6.3 7.3 6.9 6.7 6.6 6.2 Social benefits (percent of GDP) 15.6 18.0 16.9 16.1 16.1 16.1 Capital expenditures (percent of GDP) 3.4 3.2 4.2 5.4 5.7 5.8 Fiscal balance (percent of GDP) -2.1 -8.3 -5.4 -5.3 -4.7 -3.7 Overall fiscal balance with the Public Enterprise -3.1 -8.8 -5.8 -5.7 -5.1 -4.0 for State Roads included (percent of GDP) Primary fiscal balance (percent of GDP) -1.0 -7.1 -4.1 -4.0 -3.5 -2.5 Public debt (percent of GDP) 40.4 51.9 51.8 53.7 55.3 55.1 Public and publicly guaranteed debt (percent of GDP) 49.2 61.0 60.8 62.7 64.3 64.1 Of which: External (percent of GDP) 32.7 40.7 39.8 41.1 41.2 39.6 Goods exports (percent of GDP) 47.5 45.3 51.1 52.0 53.0 53.9 Goods imports (percent of GDP) 64.8 62.3 71.3 72.9 73.6 74.2 Net services exports (percent of GDP) 3.0 4.0 4.3 4.3 4.5 4.8 Trade balance (percent of GDP) -14.3 -13.0 -15.9 -16.6 -16.1 -15.5 Net remittance inflows (percent of GDP) 1.7 2.7 2.9 3.1 3.1 3.1 Current account balance (percent of GDP) -3.3 -3.4 -3.5 -4.0 -3.3 -2.9 Net foreign direct investment inflows (percent of GDP) 3.2 1.5 3.7 3.8 3.8 3.9 External debt (percent of GDP) 72.4 80.3 81.4 82.8 82.0 81.4 Real private credit growth (percent, period average) 6.5 5.7 2.8 - - - Nonperforming loans (percent of gross loans, end of period) 4.6 3.3 3.1 - - - Unemployment rate (percent, period average) 17.3 16.4 15.7 14.7 13.9 13.5 Youth unemployment rate (percent, period average) 35.6 35.7 36.3 - - - Labor force participation rate (percent, period average) 57.2 56.4 56.0 - - - GDP per capita, PPP (current international $) 14,230 13,360 13,890 14,265 14,707 15,177 Poverty rate (percent of population) 16.5 18.3 17.2 16.4 15.9 15.1 Source: Country authorities, World Bank estimates and projections. Note: Youth unemployment rate is for labor force aged 15–24. 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 $5.5/day per person in revised 2011 PPPs. 96  |  North Macedonia STEERING THROUGH CRISES Serbia • Growth in 2021 turned out stronger than expected, despite the weather-related underperformance in agriculture. • Inflation accelerated more rapidly than projected, with the policy response encompassing central bank repo operations and selective price controls introduced by the government. • The fiscal deficit turned lower than anticipated, while public debt plateaued at around 57 percent of GDP. • Growth is projected to decelerate significantly in 2022 due to external developments, with risks to the outlook clearly tilted to the downside. • Despite fiscal risks stemming from economic slowdown and the ongoing energy crisis, the fiscal deficit in 2022 is expected to remain unchanged compared to 2021. Recent Economic Developments 5.4 percent in real terms. Agriculture output suffered from weather-related shocks, which After the pandemic-induced recession in had an impact across different agricultural 2020, real output grew by 7.4 percent in subsectors and a significant increase in the 2021. Economic growth was driven primarily cost of food used in livestock breeding and of by a surge in private consumption, but also fertilizers. Moreover, repeated breakdowns of an acceleration in total investment. A strong EPS’ electricity production and supply in Q4 increase in salaries and in lending to households and emergency imports of natural gas put a as well as transfers from the budget helped private break on the otherwise strong rebound in real consumption growth of 7.6 percent (y/y, in real GDP growth in 2021. terms). Meanwhile, investment soared by close to 15 percent in real terms. The main reason for While countercyclical fiscal measures helped the overall growth of investment is much higher mitigate the impact of the pandemic on government investment (up 49.8 percent in the labor market in 2020, the situation real terms). Government consumption rose deteriorated slightly in 2021 as some of the 2.7 percent (in real terms). Although the export government support programs have been performance was strong (up 19.4 percent in real unwound and since there was an increase terms), the increase in imports was similar (up in labor force participation. According 19.3 percent in real terms in 2021, but from to the Labor Force Survey (LFS) data, the a higher level); thus, the net balance in goods unemployment rate deteriorated slightly in and services made a negative contribution to 2021 climbing to 11 percent compared to growth of 2.1 percentage points. The economic 9.7 percent in 2020.9 The increase in the recovery in 2021 was broad based seen from unemployment rate is in part explained by the production side, with the exception of the the closure of some large, foreign-owned agriculture sector, where output declined by manufacturers, resulting in significant layoffs, 9 The labor market improvement in 2020 (when the unemployment rate went down to 9.7 percent from 11.2 percent in 2019) was primarily the result of the fiscal stimulus program, since one of the requirements for firms to receive government support was to ensure that total employment remained unchanged or decreased by a maximum of 10 percent. Serbia  |  97 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 including in the footwear and garments offset by imports driven by pent-up private industries. Wages kept rising by 9.6 percent in consumption and investment (which in turn nominal terms in 2021, although the increase led to a fast increase in intermediate and capital in real terms is less pronounced (5.4 percent, goods). In euro terms, export of goods increased y/y) as inflation started to pick up in the second by 26.8 percent, y/y, while, imports increased half of the year. Unlike in previous years, private by 24.6 percent, y/y, but from a higher base. sector wages increased faster than public sector Exports were also helped by an improvement wages (up by 11.2 percent in nominal terms, in the terms of trade—export prices increased compared to a 7.0 percent increase in public by 12.7 percent, whereas import prices grew sector wages). Despite such developments, on 10 percent. Net foreign direct investment (FDI) average, in 2021 wages in the public sector inflows stood at 6.8 percent of GDP, thus fully were still about 15.4 percent higher than in the financing the external shortfall, after growing private sector. 23.4 percent in 2021 (in euro terms). Most of the FDI went to manufacturing (37.9 percent The consolidated fiscal deficit narrowed of the total); followed by construction significantly to 4.1 percent of GDP in 2021, (20.1 percent) and transport (12.3 percent). according to the preliminary data. General Fitch Ratings affirmed Serbia’s sovereign issuer government revenues rose by 20.3 percent rating at BB+, with a stable outlook.10 in nominal terms (y/y). While all sources of fiscal revenue increased, social insurance Inflation increased sharply, in line with contributions and VAT have the largest developments in other CEE countries. contribution to the overall good performance Inflation in in the first half of 2021 was low and of revenues. At the same time, government stable, with prices growing by just 2.3 percent expenditures grew by 10.1 percent (in nominal (y/y). However, during the summer a gradual terms), led by a significant increase in capital increase in inflation took place as food and expenditures. Thanks to the smaller than energy prices started to rise and the consumer expected fiscal deficit, gross financing needs price index (CPI) peaked at 7.9 percent (y/y) decreased, leaving public debt at 57.1 percent in December. This was the highest level of of GDP at end-December 2021, roughly inflation since July 2013. In February 2022, unchanged from end-2020. prices continued to increase to 8.8 percent notwithstanding the selective Government Soaring merchandise exports and favorable price controls (of some of the core food items, terms of trade helped limit the deterioration in electricity and fuel for motor vehicles). In the current account deficit (CAD) stemming response to mounting inflation pressures, the from the surge in private consumption and National Bank of Serbia (NBS) increased the investment, on a demand side. The CAD volume and percentage of sterilized excess stood at preliminary 4.4 percent of GDP for liquidity from the banking sector through 2021, up from 4.1 percent in 2020. The trade repo operations increased the average repo deficit widened by about 14 percent as large rate, while the key policy rate has been left merchandise exporters resumed operations unchanged till April 2022, when it was after the pandemic, but this was more than increased by 50bps to 1.5 percent. The money 10 As of February 25th statement. 98  | Serbia STEERING THROUGH CRISES supply increase was also notable: by end-2021, about Euro 1 billion annually, FDI about M1 was 14.8 percent higher than a year before. Euro 220 million annually, remittances about As in 2020, the nominal dinar exchange rate Euro 80 million and tourism revenues about was stable throughout 2021, with only a minor Euro 140 million annually. Further downward depreciation in late February 2022. In January revisions are possible depending on the length 2022, the NBS held official foreign currency of the conflict and the scope of sanctions reserves in the amount of EUR 16.1 billion, toward Russia, as well as the implications on which covers six months of imports. energy prices and availability. Finally, economic slowdown is expected among main Serbia’s Banking sector performance continued to trade partners which will in turn lead to a be robust. Based on Q4 data, banks remained slowdown in Sebian exports. Over the medium profitable in 2021 with both return on assets term, the economy is expected to grow steadily (ROA) and return on equity (ROE) increasing at around 3 percent annually, similarly to levels compared to 2020. In 2021, ROE increased to before the pandemic, as the economies of the reach 7.8 percent in Q4 2021. Nonperforming main trading and investment partners rebound loans (NPLs) continued to gradually decline from the pandemic and the Ukraine war. The and stood at 3.6 percent in December 2021. In main driver of GDP growth over the medium 2022, a new challenge emerged, as the Russia/ term will be consumption (and to smaller Ukraine crisis pushed the NBS to conclude, in extent investment), while net exports will make line with domestic regulation and international a negative contribution to growth. It is expected resolution standards the process of Sberbank’s that the services sector will remain the main takeover by the local AIK bank. There are two driver of economic growth going forward. other banks with Russian owners (API and Expo bank) as well as one insurance company Macroeconomic stability will be maintained (Sogaz), which have not been affected by the over the medium term despite several risks sanctions introduced in late February. that could materialize in 2022. First, inflation is likely to increase further depending on international food and energy prices, which Outlook and Risks in turn depend on developments related to the Russia/Ukraine crisis. In addition, the Following the outbreak of war in Ukraine, 2022 fiscal deficit could be higher than the growth projections have been reduced to one projected under the base case scenario 3.2 percent in 2022 from the originally (4.1 percent of GDP). In addition to the crisis expected 4.4 percent. After better-than- slowing down real GDP growth, and thus fiscal expected growth in 2021, on the back of a revenues, the government announced new significant yet declining fiscal stimulus, the spending not originally included in the budget. Serbian economy was expected to continue Furthermore, the crisis in the EPS and Srbijagas to grow at around 4 to 4.5 percent annually. will most likely require significant additional However, the Russia/Ukraine crisis will subsidies and guarantees for liquidity and certainly have an impact on Serbia’s exports, investment purposes. Consequently, public FDI, remittances, and tourism revenues. debt could start rising again as a share of GDP. Exports to Russia and Ukraine combined are Serbia  |  99 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 The outlook also crucially depends on the domestic reform agenda and its implementation. The ongoing crisis in the domestic energy sector emphasized once again the importance of improved management of SOEs. Reforms of Srbijagas and EPS have made only slow progress and the two companies have not had a permanent management for many years. In addition, contingent liabilities could affect public finances, particularly those related to the deterioration in the performance of SOEs. The government, therefore, needs to embark on a comprehensive and thorough reform of SOEs to make them financially sound and viable. In addition, the government could use the opening of new chapters of the EU accession to accelerate governance and green transition reforms and align the Serbian legal and institutional system to that of the EU. 100  | Serbia STEERING THROUGH CRISES The GDP recovered well in 2021… …in line with developments among CEE countries. Contribution to growth, percentage points Growth rates, y/y 25 15 20 12 9 15 6 10 3 5 0 0 -3 -6 -5 -9 -10 -12 9 9 9 9 0 0 0 0 1 1 1 1 6 6 7 7 8 8 9 9 0 0 1 1 -2 -2 -2 -2 -2 -2 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -2 -2 -2 -2 -2 -2 Q1 Q3 Q1 Q2 Q4 Q1 Q3 Q3 Q1 Q2 Q3 Q4 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q2 Q3 Q4 Q1 Q3 J Consumption, final J Investment ▬ Serbia ▬ CEE8 average J Net exports ▬ Real GDP growth, percent Source: Statistics Office of the Republic of Serbia. Source: Statistics Office of the Republic of Serbia and Eurostat. The public debt stabilized... ...despite a significant increase of debt in euro terms Share in GDP EUR million 80 4,000 3,465 70 3,000 2,661 60 50 2,000 40 1,000 929 30 0 20 -195 10 -1,000 0 -1,612 -2,000 p 10 11 12 13 14 15 16 17 18 19 08 09 20 21 20 20 20 20 20 20 20 20 20 20 2017 2018 2019 2020 2021p 20 20 20 20 Source: Ministry of Finance. Source: Ministry of Finance. The CAD and trade deficit recently started to Inflation has been increasing since April. increase. Percent of GDP, 12-months sum CPI, y/y 0 9 -2 8 -4 7 6 -6 5 -8 4 -10 3 -12 2 -14 1 -16 0 15 16 17 18 19 20 21 22 18 18 10 8 8 19 19 10 9 9 4/ 0 20 10 0 0 21 21 10 1 1 2 /2 1 /1 1 /1 2 2 /2 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 4/ 7/ 1/ 1/ 4/ 7/ 1/ 4/ 7/ 1/ 7/ ▬ CAB ▬ Trade balance ▬ CPI, total ▬ Target, upper bound ▬ Target, lower bound Source: National Bank of Serbia. Source: National Bank of Serbia. Serbia  |  101 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 SERBIA 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) 4.3 -0.9 7.4 3.2 2.7 2.8 Composition (percentage points): Consumption 2.9 -0.9 5.7 4.0 3.4 3.1 Investment 4.0 -0.1 3.8 1.1 0.9 1.0 Net exports -2.6 0.1 -2.1 -1.8 -1.6 -1.4 Exports 4.1 -2.3 10.3 3.3 3.0 3.1 Imports (-) 6.7 -2.4 12.4 5.1 4.6 4.5 Consumer price inflation (percent, period average) 1.9 1.6 4.0 7.0 5.3 4.1 Public revenues (percent of GDP) 42.0 41.0 43.3 42.3 43.0 43.1 Public expenditures (percent of GDP) 42.2 49.0 47.4 46.3 46.0 45.3 Of which: Wage bill (percent of GDP) 9.5 10.5 10.0 10.1 10.2 10.3 Social benefits (percent of GDP) 14.4 14.7 13.6 14.0 14.0 14.2 Capital expenditures (percent of GDP) 4.9 5.3 7.4 7.4 7.0 7.2 Fiscal balance (percent of GDP) -0.2 -8.0 -4.1 -4.1 -3.0 -2.2 Primary fiscal balance (percent of GDP) 1.8 -6.0 -2.4 -2.3 -1.0 -0.3 Public debt (percent of GDP) 48.8 53.9 53.9 52.8 53.2 51.8 Public and publicly guaranteed debt (percent of GDP) 52.8 57.8 57.1 58.2 58.9 56.8 Of which: External (percent of GDP) 30.3 33.4 37.0 38.0 40.0 40.0 Goods exports (percent of GDP) 35.7 34.4 38.9 38.0 38.6 39.9 Goods imports (percent of GDP) 47.9 45.5 50.1 49.9 49.8 50.1 Net services exports (percent of GDP) 2.3 2.4 2.7 2.4 2.1 2.6 Trade balance (percent of GDP) -9.9 -8.8 -8.5 -9.5 -9.1 -7.6 Net remittance inflows (percent of GDP) 5.6 4.5 4.7 4.5 4.4 4.2 Current account balance (percent of GDP) -6.9 -4.1 -4.4 -6.4 -5.8 -5.1 Net foreign direct investment inflows (percent of GDP) 7.7 6.3 6.8 5.8 6.3 6.2 External debt (percent of GDP) 61.8 65.8 68.6 65.3 63.1 61.0 Real private credit growth (percent, period average) 6.9 9.2 3.7 - - - Nonperforming loans (percent of gross loans, end of period) 4.1 3.7 3.6 - - - Unemployment rate (percent, period average) 11.2 9.7 11.0 10.0 9.5 9.5 Youth unemployment rate (percent, period average) 28.6 27.3 26.5 - - - Labor force participation rate (percent, period average) 52.9 52.2 54.7 - - - GDP per capita, PPP (current international $) 19,025 19,168 21,243 22,901 24,599 26,271 Poverty rate (percent of population) 10.1 10.2 9.8 9.6 9.3 9.1 Source: Country authorities, World Bank estimates and projections. Note: 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 $5.5/day per person in revised 2011 PPPs. 102  | Serbia Key Economic Indicators WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Key Economic Indicators 2019 2020 2021p 2022f 2023f 2024f Real GDP growth (percent) Albania 2.2 -3.5 8.5 3.2 3.5 3.5 Bosnia and Herzegovina 2.8 -3.1 7.1 2.7 3.1 3.5 Kosovo 4.8 -5.3 9.1 3.9 4.3 4.2 North Macedonia 3.9 -6.1 4.0 2.7 3.1 3.2 Montenegro 4.1 -15.3 12.4 3.6 4.7 3.7 Serbia 4.3 -0.9 7.4 3.2 2.7 2.8 WB6 3.7 -3.2 7.4 3.1 3.1 3.2 Consumer price inflation (percent, period average) Albania 1.4 1.6 2.6 5.5 4.0 3.0 Bosnia and Herzegovina 0.6 -1.1 2.0 6.5 2.3 0.5 Kosovo 2.7 0.2 3.4 5.4 1.6 2.2 North Macedonia 0.8 1.2 3.2 5.5 2.0 1.8 Montenegro 0.4 -0.3 2.4 5.0 2.3 1.6 Serbia 1.9 1.6 4.0 7.0 5.3 4.1 WB6 1.5 0.9 3.3 6.3 3.8 2.8 Public expenditures (percent of GDP) Albania 29.2 32.6 31.5 32.1 29.9 29.6 Bosnia and Herzegovina 40.6 44.0 44.8 41.7 40.2 39.4 Kosovo 29.7 33.0 30.1 30.6 30.9 30.7 North Macedonia 33.5 38.9 37.7 38.4 38.0 37.2 Montenegro 46.0 55.5 45.6 46.3 43.9 42.4 Serbia 42.2 49.0 47.4 46.3 46.0 45.3 WB6 36.9 42.2 39.5 39.2 38.1 37.4 Public revenues (percent of GDP) Albania 27.2 25.9 27.0 27.1 27.2 27.3 Bosnia and Herzegovina 42.6 42.2 42.3 40.5 40.4 40.5 Kosovo 26.8 25.4 28.7 28.4 28.2 28.2 North Macedonia 31.4 30.5 32.3 33.1 33.2 33.5 Montenegro 43.3 44.4 43.6 41.1 40.9 40.7 Serbia 42.0 41.0 43.3 42.3 43.0 43.1 WB6 35.5 34.9 36.2 35.4 35.5 35.5 Source: World Bank calculations and projections on data from national authorities. 104  | Key Economic Indicators STEERING THROUGH CRISES Key Economic Indicators (continued) 2019 2020 2021p 2022f 2023f 2024f Fiscal balance (percent of GDP) Albania -1.9 -6.7 -4.5 -5.0 -2.6 -2.4 Bosnia and Herzegovina 1.9 -1.8 -2.5 -1.2 0.2 1.1 Kosovo -2.9 -7.6 -1.4 -2.2 -2.6 -2.5 North Macedonia -2.1 -8.3 -5.4 -5.3 -4.7 -3.7 Montenegro -2.7 -11.0 -2.0 -5.2 -3.0 -1.7 Serbia -0.2 -8.0 -4.1 -4.1 -3.0 -2.2 WB6 -1.3 -7.3 -3.3 -3.8 -2.6 -1.9 Public debt (percent of GDP) Albania 63.7 74.0 72.1 72.0 70.2 69.0 Bosnia and Herzegovina 32.8 36.6 34.4 33.2 34.0 35.3 Kosovo 17.0 22.0 22.1 24.0 25.3 26.9 North Macedonia 40.4 51.9 51.8 53.7 55.3 55.1 Montenegro 76.5 105.3 84.9 77.4 75.2 73.1 Serbia 48.8 53.9 53.9 52.8 53.2 51.8 WB6 46.5 57.3 53.2 52.2 52.2 51.9 Public and publicly guaranteed debt (percent of GDP) Albania 67.4 75.9 74.0 73.9 72.1 70.9 Bosnia and Herzegovina 34.5 38.8 36.6 35.1 36.0 37.5 Kosovo 17.6 22.4 22.5 24.3 25.4 27.0 North Macedonia 49.2 61.0 60.8 62.7 64.3 64.1 Montenegro 80.0 108.7 87.7 80.1 77.6 75.4 Serbia 52.8 57.8 57.1 58.2 58.9 56.8 WB6 50.3 60.8 56.5 55.7 55.7 55.3 Goods exports (percent of GDP) Albania 6.6 6.0 8.2 6.8 6.7 6.7 Bosnia and Herzegovina 28.8 27.5 34.1 34.1 34.5 36.2 Kosovo 5.6 6.9 9.9 9.8 9.8 9.9 North Macedonia 47.5 45.3 51.1 52.0 53.0 53.9 Montenegro 9.4 9.8 10.7 11.5 11.1 11.1 Serbia 35.7 34.4 38.9 38.0 38.6 39.9 WB6 28.5 27.6 32.0 31.5 31.9 32.8 Source: World Bank calculations and projections on data from national authorities. Key Economic Indicators  |  105 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.21 Key Economic Indicators (continued) 2019 2020 2021p 2022f 2023f 2024f Trade balance (percent of GDP) Albania -13.8 -14.4 -13.3 -12.1 -10.5 -9.5 Bosnia and Herzegovina -14.7 -14.0 -12.3 -12.8 -12.5 -12.6 Kosovo -27.1 -31.6 -32.7 -32.9 -31.7 -30.4 North Macedonia -14.3 -13.0 -15.9 -16.6 -16.1 -15.5 Montenegro -21.1 -35.0 -19.6 -20.7 -19.7 -19.4 Serbia -9.9 -8.8 -8.5 -9.5 -9.1 -7.6 WB6 -13.6 -13.6 -12.8 -13.4 -12.7 -11.8 Current account balance (percent of GDP) Albania -8.0 -8.5 -7.7 -7.9 -6.4 -5.3 Bosnia and Herzegovina -2.9 -3.9 -2.3 -3.2 -3.0 -2.6 Kosovo -5.6 -7.0 -9.1 -9.7 -9.0 -8.0 North Macedonia -3.3 -3.4 -3.5 -4.0 -3.3 -2.9 Montenegro -14.3 -26.1 -9.2 -12.6 -12.1 -12.0 Serbia -6.9 -4.1 -4.4 -6.4 -5.8 -5.1 WB6 -6.2 -5.7 -4.9 -6.3 -5.6 -5.0 External debt (percent of GDP) Albania 60.0 65.6 58.1 56.7 57.0 56.9 Bosnia and Herzegovina 65.6 70.7 65.4 60.3 58.1 58.7 Kosovo 31.2 37.2 37.3 - - - North Macedonia 72.4 80.3 81.4 82.8 82.0 81.4 Montenegro 169.0 224.1 199.0 194.8 190.9 188.4 Serbia 61.8 65.8 68.6 65.3 63.1 61.0 WB6 76.7 90.6 85.0 92.0 90.2 89.3 Unemployment rate (period average, percent) Albania 11.5 11.7 11.5 - - - Bosnia and Herzegovina 15.7 15.9 17.4 - - - Kosovo 25.7 24.5 - - - - North Macedonia 17.3 16.4 15.7 14.7 13.9 13.5 Montenegro 15.1 17.9 16.6 - - - Serbia 11.2 9.7 11.0 10.0 9.5 9.5 WB6 16.1 16.0 - - - - Source: World Bank calculations and projections on data from national authorities. 106  | Key Economic Indicators Western Balkans Regular Economic Report No.21 | Spring 2022 View this report online: www.worldbank.org/eca/wbrer