87962 SOUTH EAST EUROPE Regular Economic Report May 201 4 No.6 Brittle Recovery Report No. 87962-ECA South East Europe Regular Economic Report No.6 Brittle Recovery May 2014   Acknowledgments This Regular Economic Report (RER) covers economic developments, prospects, and policies in six South Eastern European countries (SEE6): Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. The report is produced twice a year by staff of economists at the World Bank Europe and Central Asia Region Poverty Reduction and Economic Management Department (ECA PREM). The team of authors comprises Gallina A Vincelette (task team lead and lead author), Željko Bogetić (lead author), Simon Davies (lead author), Abebe Adugna, Agim Demukaj, Doerte Doemeland, Sandra Hlivnjak, Anil Onal, Suzana Petrovic, Lazar Sestović, Sanja Madzarević-Sujster, Hilda Shijaku and Bojan Shimbov. Mizuho Kida and Wolfgang Fengler provided inputs on global developments and global outlook, and financial sector issues, respectively. Maria Andreina Clower, Christopher Pala, and Budy Wirasmo provided invaluable assistance in editing and designing this report. Dissemination of the report and external and media relations is managed by an EXR team Lundrim Aliu, Boris Balabanov, Anita Bozinovska, Ana Gjokutaj, Jasmina Hadzić, Andrew Kircher, Vesna Kostić, Mirjana Popovć, John Mackedon, Kristyn Schrader-King, and Dragana Varezić. The team is grateful to Ellen Goldstein (Country Director, South Eastern Europe), Roumeen Islam (Acting Sector Director, ECA PREM), Satu Kähkönen (Sector Manager, ECA PREM), and the South Eastern Europe Country Management Unit for their guidance in the preparation of this report. The team is thankful for comments on earlier drafts of this report received from Central Banks and Ministries of Finance in the SEE6 countries. This and previous SEE RERs may be found at: www.worldbank.org/eca/seerer Standard Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Copyright Statement: The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, http://www.copyright.com/. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522- 2422, e-mail pubrights@worldbank.org. SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Contents Summary1 I. Recent Developments 7 Exit from Recession 7 Export-led Growth 11 Persistent Challenges Addressing High Unemployment 16 Fiscal Pressures Not Abating 19 Falling and Low Inflation  24 Stable, Albeit Fragile, Financial Sector 27 II. Prospects 33 Near-Term Growth Prospects and Medium-Term Outlook 33 Challenging Long-Term Convergence  37 III. Spotlights 43 Spotlight 1. Youth (Un)employment in the Western Balkans 43 Spotlight 2. SEE6 Non-performing loans: Effects, Obstacles to Resolving and Reforms 47 Annex I: Key Indicators 53 List of Figures Figure 1: Growth in SEE6, 2012–13 9 Figure 2: Growth of Industrial Output in 2012 and 2013 9 Figure 3: Worker Remittances 2010–2013 9 Figure 4: SEE6 Current Account and Trade & Service Balances 11 Figure 5: SEE6 Countries’ Current Account Balance 11 Figure 6: Real Unit Labor Costs Index 12 Figure 7: Contributions to Change in Unit Labor Costs since 2008 12 Figure B2.1: Import and Export Gaps in SEE6 13 Figure 8: SEE6 Export Growth 14 Figure 9: SEE6 Current Account Financing 14 Figure 10: FDI Inflows 14 Figure 11: Average SEE6 External Debt 15 iv  | Contents BRITTLE RECOVERY Figure 12: Total Public and Private External Debt 2011–13 15 Figure 13: Employment Index SEE, EU11, EU15 16 Figure 14: Employment Index SEE Countries 16 Figure 15: Unemployment in SEE, EU 11 and EU 15 17 Figure 16: Unemployment, Q4 2013 17 Figure 17: Change in Youth and Adult Unemployment 17 Figure 18: Youth Unemployment by Wealth 17 Figure 19: Fiscal Deficits 19 Figure 20: Change in Revenues, 2009–13 19 Figure 21: Average Contribution Towards Change in Revenues 19 Figure 22: Taxes on International Trade 20 Figure 23: Trade Taxes as % Total Revenue 20 Figure 24: Capital Expenditure 21 Figure 25: Contribution Toward Change in Deficit, 2013–14 21 Figure 26: Public Debt and Guarantees 22 Figure 27: CPI Inflation 24 Figure 28: Regional CPI Inflation Comparison 24 Figure 29: Food Price Inflation 25 Figure 30: Energy Price Inflation 25 Figure 31: Output Gaps in SEE6 25 Figure 32: Official Policy Rates 26 Figure 33: Real Broad Money Supply 26 Figure 34: Funding and Funding Costs for SEE6 27 Figure 35: CDS Spreads of SEE6 27 Figure 36: Return on Assets (ROA), quarterly averages 28 Figure 37: Loan-to-Deposit Ratios 28 Figure 38: Liquidity Ratio 28 Figure 39: Capital Adequacy Ratio 28 Figure 40: Non-performing Loans 29 Figure 41: Credit Growth Rates 29 Figure 42: SEE6 Real GDP Growth Rate under Baseline and Low Case Scenarios 36 Figure 43: 2012 GDP Per Capita 37 Figure 44: SEE GDP Per Capita (PPP) as % EU Average 37 Figure 45: Income Convergence 38 Figure S1.1: Youth unemployment rate, 2012 43 Figure S1.2: Change in unemployment rate, 2008–12 43 Figure S1.3: Number of elderly per ten working age people 44 Contents  |  v SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure S1.4: Yearly change in youth and adult unemployment rate versus GDP growth 45 Figure S2.1: Banks’ Non-Performing Loans 47 List of Tables  outh East Europe: Real GDP growth S 1 Table 1: Growth of Goods Exports 7 Table 2: Sovereign Debt Ratings 23 Table 3: Real GDP Growth and Projections 33 Overview of Programs and Reforms under Way to Address NPLs Table S2.1:  in the Western Balkans 48 List of Boxes Box 1: Global Economic Developments 8 Box 2: Trade Potential for SEE 12 Box 3: Global Outlook and Risks 35 Box 4: Demographic Challenges to Income Convergence in SEE6 39 vi  | Contents BRITTLE RECOVERY Summary Recent Economic Developments domestic consumption or investment in SEE6. Domestic demand was further suppressed South East Europe (SEE6)’s economy by declining remittances to SEE6 in 2013, recovered from the 2012 recession, growing by reflecting a still sluggish economic recovery 2.2 percent on average in 2013.1 Each of the and prevailing high unemployment in host SEE6 countries marked positive growth rates in countries (mostly in the EU). 2013, with growth at or exceeding 3 percent in Kosovo, FYR Macedonia and Montenegro. On the production side, SEE6 drivers of growth were mixed, but in all countries a good  South East Europe: Real GDP growth agricultural year supported economic activity. percent Output growth in Serbia, Albania, and Bosnia 2012 2013 2014 2015 and Herzegovina was led by industry and Albania 1.3 0.4 2.1 3.3 agriculture. In FYR Macedonia, it was due to construction. Montenegro grew on the back of Bosnia and Herzegovina -1.1 1.8 2.0 3.5 a broad-based rebound. Kosovo 2.7 3.0 3.5 3.5 FYR Macedonia -0.4 3.1 3.0 3.5 An export-led recovery combined with Montenegro -2.5 3.5 3.2 3.5 depressed domestic demand resulted in a Serbia -1.7 2.5 1.0 1.5 significant narrowing of current account SEE6* -0.7 2.2 1.9 2.6 imbalances in all SEE6 countries. Both increases Memo item: in exports and declines in imports contributed Euro Area -0.7 -0.4 1.2 1.7 to a decrease in trade deficits by 4.9 percent Source: World Bank. Note: *GDP weighted average. 2013 is an estimate. 2014 and 15 are of GDP and in current account deficits by World Bank staff projections. 3.5 percent of GDP in 2013. The sustainability of this high export growth is uncertain, given External demand for SEE6 exports, especially SEE6’s narrow export base and competitiveness by the European Union (EU), was the key driver issues stemming from decreases in productivity of the recovery. SEE6 exports expanded by close and increases in real wages. to 17 percent in 2013, led by Serbian exports which surged by 25.6 percent. In contrast, the Foreign direct investment (FDI) and portfolio region’s domestic demand contracted at a pace investment financed most of the current of 1.4 percent in 2013. With few new jobs account deficits in SEE6. FDI inflows increased and limited credit to the economy, household to 2.9 percent of GDP. They went mostly to income and firms’ profits were unable to boost manufacturing in FYR Macedonia and to infrastructure in Kosovo and Albania. 1 The SEE6 comprises the following countries: Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. Summary  |  1 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Overall, SEE6 countries are having limited fiscal deficits. Overall public debt and public success in translating the economic recovery guarantees remained over 60 percent of GDP into job creation. With the rebound in export- in Albania, Montenegro, and Serbia at end- led activity, employment in SEE6 increased 2013. in 2013 in FYR Macedonia, Montenegro and to a lesser extent in Bosnia and Herzegovina. In a low-inflation environment, SEE6 central However, employment declined in Serbia banks moderately loosened monetary policy. To and Albania. Unemployment remained high support liquidity and enhance access to finance, in SEE6 at an average rate of 24.2 percent in central banks in Albania, FYR Macedonia 2013. High unemployment rates and the large and Serbia cut key interest rates by 1, 0.5 and share of chronic unemployment are prevalent 1.75 percentage points, respectively, in 2013. among vulnerable groups such as youth and the Given the limited scope of their monetary low-skilled. policy, Kosovo, and Montenegro reduced the reserve requirement rate relative to the pre- SEE6 countries reduced their fiscal deficits to crisis level, in order to ease financing. 3.8 percent of GDP in 2013 from 4.3 percent of GDP in 2012. With sluggish growth, The financial sector remained broadly stable, deflationary pressures and the shift toward albeit fragile, in the course of 2013. Even external demand-driven growth, revenues though funding conditions for SEE6 countries came under pressure, falling by an average of improved in the second half of 2013, foreign 0.5 percent of GDP in 2013. But spending bank deleveraging continued. Banks in SEE6 fell by 1 percent of GDP on average and remained liquid and well capitalized. However, compensated for the loss in revenues. Despite two interrelated challenges remain and need these efforts, fiscal consolidation measures action: taming the still rising non-performing were not enough to restore fiscal balances in loans (NPL) and resuming credit growth, SEE6. For example, public wages remain high especially corporate lending for investment. (equal to over a quarter of total expenditures NPLs tripled over the last five years from on average and over 11 percent of GDP in an average of 5 percent to an average of Bosnia and Herzegovina, Montenegro and 16 percent at end-2013, with NPLs in Albania, Serbia), social benefits are poorly targeted (at Montenegro and Serbia above the regional 12.5 percent of GDP on average), and capital average. Rising NPLs, the introduction of expenditures are low and falling (at below tighter credit underwriting standards, and 4 percent of GDP in the end of 2013 in FYR banks’ efforts to clean their balance sheets and Macedonia, Montenegro, and Serbia). contain costs added pressure on lending and slowed credit growth to the private sector to a The pace of fiscal adjustment and still nascent crawl across SEE6 in 2013. economic growth were insufficient to reverse public debt dynamics in SEE6. Average public debt including guarantees rose from 47.7 percent of GDP in 2012 to 50.1 percent in 2013 as SEE countries borrowed to fund 2  | Summary BRITTLE RECOVERY Outlook is possible. It could be done by: taming the large public sector wage bill; improving the targeting The SEE region is projected to grow at of social transfers and benefits to those most in 1.9 percent in 2014 and 2.6 percent in need; maintaining productive spending that 2015 on the back of external demand. The addresses infrastructure bottlenecks; broadening positive growth since mid-2013 and the still the tax base; and improving revenue collection. accommodative monetary conditions of the On the monetary policy side, with very low Euro Area are likely to continue help SEE6 regional inflation at 1.2 percent and remaining exports to grow, despite notable risks related to output gaps, some scope for further gradual the outlook for the Euro Area (related to the short-term easing of monetary conditions exists slow reform implementation and prolonged in countries that peg their currencies. However, period of low inflation or risk of deflation). caution needs to be exercised in countries with Overall economic activity in SEE6 will flexible exchange rates to ensure that the rate continue to be dampened, reflecting weak does not come under pressure and/or that domestic demand. Serbia remains the slowest- inflation does not rise undesirably. In terms of growing economy and Kosovo the fastest. financial sector policies, addressing the high Serbia, the largest SEE6 economy, appears to NPLs will be critical to restore the growth of be headed toward a sizeable fiscal consolidation credit and support entrepreneurship and job to bring its debt to a sustainable level. This is creation. likely to be a drag on economic activity. In contrast, economic growth in the other five There are significant downside risks to the SEE countries is expected to firm up in 2014 macroeconomic outlook for the SEE6 region. and exceed the pace of economic expansion External risks are related to: the threat of of 2013 in line with an expected stronger deflation in the Euro Area, which could dampen external demand, some modest declines in their growth and external demand for SEE6 unemployment and improved credit conditions. exports; the pace of rising global interest rates; Albania’s growth is projected at 2.1 percent as and the potential geo-political ramifications the planned clearance of payment arrears by the of the Russia-Ukraine conflict. Domestic risks government is expected to inject liquidity into are related to: socio-political internal tensions the private sector and help accelerate growth. stemming from high levels of unemployment, The economies of FYR Macedonia, Kosovo, ongoing SOE restructuring efforts, elections and Montenegro also have some momentum in and insufficient effort in tackling long- construction, services, and tourism. In 2015, outstanding structural issues in the SEE6 Albania, Bosnia and Herzegovina, Kosovo and economies. The impact of the recent floods on Serbia are all projected to have higher or the economic activity in Bosnia and Herzegovina same growth rates than in 2014, unless risks and Serbia is not known yet, but it will likely materialize. put further downward pressure on the recovery in these two countries in 2014. Agriculture is Economic policies can be instrumental for especially likely to be hit and mining as well growth in the near- and medium-term in SEE6. as infrastructure may also be harmed. These Growth-enhancing “smart” fiscal consolidation external and domestic risks, if they materialize, Summary  |  3 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 would negatively affect prospects for growth in the SEE6 countries and slow the region’s nascent economic recovery. In an extreme case of major deterioration of economic conditions driven by these risks, SEE6 output growth in 2014 could more than halve (to 0.6 percent) compared to the baseline projection (1.9 percent). In 2015, growth would be slashed by a third (1.7 percent) compared to the baseline 2.6 percent). In the medium to long-term, reaching EU living standards will require decades of sustained effort by the SEE6 countries for improved policy, institutional and economic performance. Boosting incomes in SEE6 will mean accelerating the pace of reforms and—importantly--converting its benefits into robust and equitable economic growth. Removing structural rigidities not only in the macroeconomic policy mix, but also increasing SEE6’s global integration and connectivity, improving the economy’s productive potential and competitiveness, and strengthening institutions will ultimately give a strong push to income growth and convergence. 4  | Summary BRITTLE RECOVERY I. Recent Developments Exit from Recession The SEE6 countries exited from recession Table 1: Growth of Goods Exports in 2013 with economic growth supported million, Euro by the recovery in high-income countries, 2012 2013 change in % particularly those in the European Union ALB 1,526 1,731 13.4 (EU). After a 0.7 percent decline in 2012, the BIH 2,582 2,807 8.7 average real GDP of SEE6 grew 2.2 percent in KOS 287 305 6.3 2013 (Figure 1). All six SEE countries marked MKD 3,107 3,206 3.2 positive growth, with growth at or exceeding MNE 392 403 2.8 3 percent in Kosovo, FYR Macedonia and SRB 8,726 10,956 25.6 Montenegro. Only in Albania did economic SEE6 16,620 19,408 16.8 growth slow in 2013 compared to 2012, though Source: National Banks and World Bank staff estimates. it remained positive. External demand for SEE6 exports was the key driver of this growth With high unemployment and slow credit recovery, reflecting an improving European and recovery, domestic demand remained global economy (see Box 1).2 depressed in SEE6 in 2013. With few new jobs and limited credit for businesses and On the demand side, exports drove the households, profits and household income economic recovery. The gradual recovery in were not able to boost domestic consumption the Euro Area helped goods exports of SEE6 or investments. Domestic demand contracted expand by close to 17 percent (Table 1). by 1.4 percent. With the exception of Serbia’s exports surged (led by foreign company Montenegro, the growth in real domestic exporters such as FIAT, Gazprom, Michelin, demand was negative in the region, falling in and Stada) by 25.6 percent in 2013 compared Serbia (-2.2 percent), Bosnia and Herzegovina to 2012. Merchandise exports grew across the (-1.4 percent), Albania (-0.6 percent) and region, from 2.8 percent in Montenegro to FYR Macedonia (-0.6 percent).3 In Serbia, 13.4 percent in Albania, while services exports domestic consumption and investment had an performed worse than merchandise exports. especially large negative contribution to GDP growth of about 1.5 and 1.7 percentage points, respectively. Quarterly GDP data for Serbia, 2 Economic growth was projected at 1.8 percent in the SEE RER 3 Real domestic demand growth data from IMF WEO. Data not No.5 of December 2013. available for Kosovo. I. Recent Developments  |  7 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Box 1: Global Economic Developments Global growth recovery remained on track in the first quarter of 2014, due mainly to a strong pick up in high income countries. In the US, after a moderate deceleration in the first two months of the year, incoming data suggest that the economy is accelerating again after the deep winter freeze. Along with stronger job growth—2.4 million new jobs have been added since the start of 2014— rising stock and housing prices are boosting household income and wealth, and consumer confidence and spending are strengthening. In the Euro Area, Purchasing Managers Index data for January and February show resurgent activity in Germany and expansion everywhere else save France where confidence is nevertheless improving. The Euro Area manufacturing index also rose in March close to its highest levels in nearly three years. Significant spare capacity and persistently low Euro Area- wide inflation, however, are generating real concerns about deflation. In Japan, the domestically- driven recovery has seen a surge in industrial output growth to 12 percent (3m/3m saar) in February, the strongest since the rebound after the 2011 earth-quake and tsunami disaster. Rising private consumption in anticipation of a consumption tax hike in April should boost growth in Q1 2014 but the drag from the tax increase, without offsetting further fiscal and monetary stimulus, is set to decelerate the pace of recovery. In developing countries, industrial output growth weakened despite surging exports, mainly reflecting weaknesses in Brazil, China, and India. The lackluster industrial performance contrasts with exports from developing countries such as China, which surged in Q4 2013 and continued at 8 percent annualized pace in the three months to January. The softness in industrial production partly reflects capacity constraints among the large middle-income countries, but financial headwinds, monetary policy tightening, and lower commodity prices also contributed to slowing domestic activities. The Federal Reserve began tapering its Quantitative Easing (QE) program in January, prompted by the improving growth prospects of the U.S. economy. The reaction of financial markets was initially muted, with long-term U.S. Treasury yields remaining stable and volatility in currency markets remaining low, suggesting that a large part of the tapering impact had already been priced in. The calm was broken at the end of January when the Argentinian peso was suddenly devalued, worries about the Chinese economy grew; and other country-specific economic and political factors intruded. Gross capital flows to developing and emerging countries reached a new record low in February. Stock markets and currencies in a number of emerging economies came under pressure, and several large middle-income economies embarked on aggressive policy tightening to relieve the stress on their currencies and domestic inflation, notably Argentina, Brazil, India, Indonesia, Turkey, and South Africa. While capital flows to developing and emerging economies rebounded in March, they continue to remain sensitive to global developments. Foreign direct investment (which account for about 60 percent of overall flows) remains the most sizeable and the least volatile form of capital flow, stabilizing overall financial flows to developing countries. Growing tension in Ukraine and Russia since late February has so far caused relatively limited disruption in global financial markets except in grain markets. The VIX index, a gauge of global risk aversion, jumped 14 percent in early March while gold prices, a gauge of the geopolitical risk, were up by 15 percent by mid-March but both have subsequently come down. Wheat and maize prices have risen by 17 and 12 percent, respectively, since February, in part reflecting market concerns surrounding Ukraine and Russia, as well as dry weather in North and South America and to a lesser extent in South East Asia. 8  |  I. Recent Developments BRITTLE RECOVERY Figure 1: Growth in SEE6, 2012–13 Figure 2: Growth of Industrial Output in 2012 and 2013 percent, annual growth percent 4 12 10 3 8 2 6 4 1 2 0 0 -2 -1 -4 -6 -2 -8 -3 -10 ALB BIH KOS MKD MNE SRB ALB BIH MKD MNE SRB JJ 2012 JJ 2013 ▬▬ SEE6 Average (2012) ▬▬ SEE6 Average (2013) JJ 2012 JJ 2013 Source: National statistics offices, and World Bank staff estimates. Source: National statistical offices. and broader indicators across the region—such Figure 3: Worker Remittances 2010–2013 as credit, wages, inflation, unemployment, % of GDP imports, and household debt—all suggest 16 that domestic demand remained depressed in 14 Q1 2014 too. 12 10 The decline in remittances to SEE6 8 contributed to the depressed domestic 6 demand. Remittances to SEE6 decreased 4 as a share of GDP in 2013, reflecting a still 2 sluggish economic recovery and prevailing high unemployment in EU countries. Remittances 0 ALB BIH KOS MKD MNE SRB SEE6 to the region declined by 0.5 percentage point JJ 2011 JJ 2012 JJ 2013 as a share of GDP (Figure 3). The decline was Source: SEE6 central banks. Note: Albania, Kosovo, and Bosnia and Herzegovina define remittances related to the economic conditions migrants as including compensation of employees; Serbia and Montenegro use narrower definitions. Data for FYR Macedonia include only workers faced in their host countries. The largest drop remittances coming through official bank channels and reported as such, but not all private transfers. continued to be in Albania, where the size of the contraction was estimated at 2.2 percent of in FYR Macedonia (at 3.1 percent), it was GDP, as a result of many migrants returning mainly due to construction. Montenegro grew from Greece. (at 3.5 percent) on the back of a broad-based rebound. On the production side, SEE6 drivers of growth were mixed. The output growth in In all SEE6 countries, a good agricultural Serbia (at 2.5 percent), Albania (at 0.4 percent) year supported economic activity in 2013. and Bosnia and Herzegovina (at 0.8 percent) After a 17 percent drop in Serbia in 2012, was led by industry and agriculture, while agricultural output bounced back by 20 percent I. Recent Developments  |  9 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 in 2013. Other countries also saw rebounds in their agricultural sectors, though at more modest levels. In contrast to 2012, industrial output grew in 2013 in all SEE6  (Figure 2). Industrial growth in Montenegro was driven by a rebound of its hydro-power electricity, and in Serbia by FIAT’s new production facility. Elsewhere in SEE6, industrial activity also grew, but at a slower pace. Data from the first two months of 2014 indicate that industry continued to grow across the region, albeit at uneven rates. Available data for four countries show that industrial output grew on average by 4.7 percent over the first two months 2014 (y-o-y). As expected, after the initial jump in car exports, Serbia’s industrial output growth tapered off to 1.2 percent. At the opposite end, Montenegro and Bosnia and Herzegovina had the highest growth of industrial output among SEE6 (driven mostly by manufacturing) with 6.5 and 6.7 percent growth, respectively. 10  |  I. Recent Developments BRITTLE RECOVERY Export-led Growth An export-led recovery combined with materials. Mineral fuels exports were quite depressed domestic demand resulted in a significant in Albania and Montenegro, while significant narrowing of current account base metals were around a quarter of exports imbalances in all SEE6 countries. The from Kosovo in 2013. increases in exports and the declines in imports lowered the trade deficit of SEE countries by Declining productivity and increases in real 4.7 percent of GDP and the current account wages in some of the SEE6 countries inflated deficits by 3.4 percent of GDP in 2013 (Figure unit labor costs and harmed competitiveness. 4, Figure 5). Exports to the EU grew strongly, Real unit labor costs have increased since 2008 especially in Bosnia and Herzegovina, FYR in Bosnia and Herzegovina, Montenegro and Macedonia, and Serbia. Montenegro’s and FYR Macedonia (Figure 6). Only in Albania Kosovo’s share of exports to the SEE region was the real wage increase more than offset by increased. Manufactured goods were the productivity growth, while in Montenegro, and largest share of exports from SEE6 followed by FYR Macedonia real wages increased despite machinery and transport equipment. Jointly declining productivity (Figure 7). Serbia they comprised over 60 percent of exports in was the only country recording consistently 2013 in the region. The major increase in 2013 decreasing unit labor costs, supporting its came from export of machinery and transport competitiveness. Partly as a result, exports equipment from Serbia. Exports in FYR from the SEE6 countries to the EU remain Macedonia grew also on the back of machinery significantly below their potential (see Box 2). and transport equipment as well as chemical Figure 4: SEE6 Current Account and Trade Figure 5: SEE6 Countries’ Current Account & Service Balances Balance % of GDP % of GDP 0 0 -2 -5 -5.8 -4 -9.2 -6 -9.8 -10 -8 -10 -15 -12 -17.0 -14 -20 -21.6 -21.7 -16 -18 -25 -20 2011 2012 2013 ALB BIH KOS MKD MNE SRB SEE6 JJ Current account balance JJ Trade balance (including services) JJ 2011 JJ 2012 JJ 2013 Source: Central banks, IMF WEO, and World Bank staff calculations. Source: SEE6 Central Banks. Note: MNE CAD improvement happened every year in Q3 due to main tourist season producing a much lower annual CAD. I. Recent Developments  |  11 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure 6: Real Unit Labor Costs Index Figure 7: Contributions to Change in Unit Labor Costs since 2008 2008=100 percentage points 130 15 120 10 5 110 0 100 -5 90 -10 80 -15 70 -20 60 -25 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ALB BIH MKD MNE SRB ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE ▬▬ SRB JJ Real wage growth JJ Productivity growth QQ Total change in unit labor costs Source: National statistics offices, World Bank staff estimates. Source: National statistics offices, World Bank staff estimates. Note: 2009 reflects a structural break in the data for FYR Macedonia due to revisions in methodology in the definition of gross wages. Box 2: Trade Potential for SEE Trade theory predicts that the introduction of a free trade area should contribute to economic development and improved regional cooperation. For SEE countries, the CEFTA (Central European Free Trade Agreement) may also be an important part of achieving a smoother transition and accession to the EU. An empirical estimation based on gravity models4 suggests that participating in the CEFTA between 2006 and 2012 had a significant positive effect on trade flows for SEE, increasing exports from SEE countries to CEFTA members by around 72 percent in the observed time period. Overall, the results suggest that SEE exporters are exploiting the opportunities provided by the free trade agreement. However, despite the benefits provided by the CEFTA, trade between SEE countries and the EU still appears to be below potential. • Imports from the EU are estimated to be below potential by between 18 and 33 percent, depending upon the country. Lower than potential imports may mean that firms and consumers are paying more for domestically produced goods than they would for imports, harming firm competitiveness and reducing consumer purchasing power. • Exports are also considerably below potential. Albanian exports to the EU are estimated at 40 percent below potential, the highest in the SEE. FYR Macedonia and Bosnia and Herzegovina are around 33 percent less than their potential while Montenegro, Serbia and Kosovo export around 27 percent less to the EU than their estimated potential. 4 Gravity models estimate trade potential between countries or regions based on their GDPs, proximity and shared characteristics such as language or legal systems. 12  |  I. Recent Developments BRITTLE RECOVERY Increasing trade with the EU could help to boost employment and growth as well as helping countries to address macroeconomic imbalances. • On average, exports are estimated to be further below potential than imports. Redressing both would therefore help to address the large current account deficits most countries in the region have. • Increasing export opportunities would boost domestic production and increase economic growth through the net export channel. • Higher exports could lead to more job opportunities in exporting firms. What can be done to help SEE countries catch up with their export potential? Weak business environments in many SEE countries hamper firm growth and exports. For example, more streamlined trade rules and regulations are needed. The Doing Business Survey finds that significant time is needed to export in all SEE countries. It takes 12 days to export in FYR Macedonia and Serbia; in Montenegro 14; Kosovo 15; Bosnia and Herzegovina 16 and Albania 19 days. Ensuring that EU safety standards for certified Figure B2.1: Import and Export Gaps in SEE6 production (e.g. agriculture) are met could also help to boost exports to the EU market. Better % of potential imports and exports, respectively, period average connectivity through transport may also be 2006–12 important. For example, by ensuring that the 0 Sava River is navigable by medium-sized vessels. -5 -10 It is reasonable to expect SEE countries to -15 become more integrated with the EU economy, -20 not least because all these countries are potential -25 candidates for EU membership. Structural -30 changes to improve the business and trade environments, as well as building institutions -35 that create opportunities for local business -40 to benefit from freer trade would allow SEE -45 countries to benefit from their proximity—both ALB BIH KOS MKD MNE SRB SEE6 JJ Exports JJ Imports geographically and economically—with EU Source: World Bank staff estimations. countries. The structure of financing of current account grew strongly from 18.4 percent in 2012 to deficits (CAD) improved (Figure 8), with 63 percent in 2013. The largest effect was in most of the financing coming from foreign FYR Macedonia, followed by about 87 percent direct investment (FDI) and portfolio of CAD in Albania, over two-thirds in Kosovo investment. Direct investment was the largest and Montenegro, about half in Serbia, and one- source of financing in 2013, accounting for third in Bosnia and Herzegovina (which saw almost two-thirds of the CAD financing a decline in importance in the second half of (Figure 9). The FDI share of the CAD financing the year). Portfolio investment played a crucial I. Recent Developments  |  13 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure 8: SEE6 Export Growth Figure 9: SEE6 Current Account Financing percent % of current account deficit 35 250 30 200 25 150 20 15 100 10 50 5 0 0 -50 -5 -10 -100 -15 -150 ALB BIH KOS MKD MNE SRB SEE6 ALB BIH KOS MKD MNE SRB SEE6 JJ 2011 JJ 2012 JJ 2013 JJ Direct investment JJ Portfolio investment JJ Other investment JJ Reserve assets JJ Net errors and emissions Source: Central banks, IMF WEO, and World Bank staff calculations. Source: Central banks, IMF WEO, and World Bank staff calculations. positive role in financing the CAD in Serbia, Figure 10: FDI Inflows but had negative effect in most other countries % of GDP except Montenegro. Other investments and 25 reserve assets registered outflows. 20 Net FDI increased in four countries in 15 2013, albeit from low levels. The regional net average increased by 1 percentage points 10 of GDP to 35.6 percent growth. A decline by 5.1 percentage points of GDP (or one third) was 5 recorded in Montenegro although it remained the best performer in SEE6 in attracting FDI 0 2009 2010 2011 2012 2013 at 9.7 percent of GDP, concentrated in real JJ SEE6 JJ EU11 JJ EU15 estate. A larger decline in outflows than inflows Source: SEE6 central banks and Eurostat. produced growing net FDI in Serbia. behind EU156 performance of 14 percent of FDI inflows in SEE6 in 2013 increased GDP (Figure 10). Inflows in FYR Macedonia— slightly to 2.9 percent of GDP, exceeding mostly in manufacturing—more than doubled EU115 at 2.6 percent, but remained far in 2013, although from a very low base. The FDI inflows grew and were directed mostly toward infrastructure projects such as the 5 EU11 countries are: Bulgaria; Croatia; Czech Republic; Estonia; 6 EU15 countries are: Austria; Belgium; Denmark; Finland; France; Hungary; Latvia; Lithuania; Poland; Romania; Slovakia; and Germany; Greece; Ireland; Italy; Luxemburg; Netherlands; Slovenia. Portugal; Spain; Sweden; and United Kingdom 14  |  I. Recent Developments BRITTLE RECOVERY Figure 11: Average SEE6 External Debt Figure 12: Total Public and Private External Debt 2011–13 % of GDP % of GDP 70 66.4 140 63.5 61.1 60 120 50 100 40 80 32.8 33.1 30 28.8 60 20 40 10 20 0 0 2011 2012 2013 ALB BIH KOS MKD MNE SRB SEE6 JJ External debt JJ o/w public debt ▬▬ Maastricht debt criterion JJ 2011 JJ 2012 JJ 2013 ▬▬ Maastricht debt criterion Source: SEE6 central banks and ministries of finance (MoF). Source: SEE6 central banks and ministries of finance; IMF; World Bank. Note: The Green line represents the Maastricht norm for debt levels. Note: MNE external debt is estimate. Kosovo private external debt is estimate and might be slightly underestimated. Its external debt also excludes potential debt to London and Paris Clubs which has to be negotiated with Serbia. Prishtina Airport and hydro-power plants for Kosovo as well as drilling in Albania. Inflows were negative in the other three countries. Despite declining slightly in 2013, SEE6’s external debt remained high. Total external debt in SEE6 declined by almost 3 percentage points to 63.5 percent of GDP in 2013, mainly because of Serbia’s large (8.3 percentage point) decline (Figure 11 and Figure 12). Private sector deleveraging drove the regional external debt decline in 2013. External debt grew slightly in Albania due to an increase in debt held by the private sector and low GDP growth (Figure 12). I. Recent Developments  |  15 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Persistent Challenges Addressing High Unemployment With the rebound in activity, employment higher than in EU11 and EU15 (Figure 15).7 in SEE6 increased slightly in 2013 ( Figure In all countries except Albania and Kosovo8 the 13). According to Labor Force Surveys, FYR unemployment rate has begun to fall from the Macedonia, Montenegro, and to a lesser extent crisis peak and in some cases has fallen even Bosnia and Herzegovina experienced increases below levels seen prior to the crisis (Figure 16). Figure 13: Employment Index SEE, EU11, Figure 14: Employment Index SEE Countries EU15 2008=100 2008=100 102 115 100 110 98 105 100 96 95 94 90 92 85 90 80 88 75 86 70 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 ▬▬ SEE5 (ex. KOS) ▬▬ EU11 ▬▬ EU15 ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: National statistics offices, World Bank staff estimates. Source: National statistics offices, World Bank staff estimates. in employment (Figure 14). However, these Long-term unemployment (defined as employment gains are a reflection of short-run unemployment that lasts longer than economic performance and are insufficient 12 months) continued to rise since the to bring down the high unemployment rates beginning of the global financial crisis. in SEE6. The long-term employment (and The global financial crisis and the subsequent unemployment rate) averages continued double dip recession in SEE6 have made it to portray poor labor and product market hard for workers who lost their jobs to find conditions (Figure 13, Figure 14). new ones. The share of long-term unemployed among the unemployed remained very high Despite increasing employment, unemployment rates remained high at a 7 EU11 comprises Bulgaria, Croatia, the Czech Republic, Estonia, staggering 24.2 percent at the end of 2013. Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, and Slovenia. The group of EU15 countries comprises: The region’s unemployment rate is much Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. 8 Latest available data for Kosovo are of 2012. 16  |  I. Recent Developments BRITTLE RECOVERY Figure 15: Unemployment in SEE, EU 11 Figure 16: Unemployment, Q4 2013 and EU 15 % of labor force % of labor force 25 40 35 33.5 33.5 20 30 27.6 30.9 25.5 28.8 25 27.5 15 20.5 23.5 20 16.1 19.5 10 15 16.1 10 5 5 0 0 2007 2008 2009 2010 2011 2012 2013 ALB MNE SRB BIH MKD KOS ▬▬ SEE5 (ex. KOS) ▬▬ EU11 ▬▬ EU15 JJ Unemployment ▬▬ SEE6 ave. ▬▬ EU11 ave. QQ Crisis-time peak Source: Countries LFS data, Eurostat. Source: National statistics offices, World Bank staff estimates. Note: Annual weighted averages by labor force. Note: 2009 reflects a structural break in the data for FYR Macedonia due to revisions in methodology in the definition of gross wages. Figure 17: Change in Youth and Adult Figure 18: Youth Unemployment by Wealth Unemployment percentage points % of labor force 12 80 70 10 60 8 50 6 40 30 4 20 2 10 0 0 EU-17 EU-11 SEE-6* ALB BIH KOS MKD MNE SRB EU11 JJ Adult unemployment JJ Youth unemployment JJ Top 60 percent JJ Bottom 40 percent QQ Bottom 20 percent Source: Eurostat, National statistics offices. Source: Household Budget Surveys. at 83 percent of the unemployed in Bosnia  Figure 17).9 At the end of 2012, the total ( and Herzegovina, 82 percent in Montenegro, unemployment rate in SEE6 had risen by 76 percent in Serbia, 72 percent in Albania and 60 percent in FYR Macedonia and Kosovo. 9 A new World Bank report (2014, forthcoming) on jobs for youth describes the key characteristics of the young in Europe. In Across the region, youth unemployment rates addition, the report examines the apparent “supercyclicality” of youth unemployment, aiming to understand how it varies across were much higher than total unemployment different parts of the continent and at different points in the cycle (i.e. booms vs. recessions). It also looks beyond the impacts of GDP growth and into the specific policies and institutions that influence youth unemployment dynamics, particularly the disincentives and barriers to work that can keep youth out of productive employment and activity. I. Recent Developments  |  17 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 around 5 percentage points relative to pre- crisis levels. Youth unemployment rates rose by twice as much. Household survey data shows that youth unemployment rates are generally higher for the poorer segments of the income distribution (Figure 18) since the young depend more heavily on labor earnings for their income. The longer this unemployment persists, the more it reinforces income disparities and impedes improvements in shared prosperity. In addition, tough labor market conditions have translated into declined labor force participation rates and an increased detachment of youth from the labor market. Increases in the number of NEET—not in education, employment, or training—illustrate this point. The low-skilled—those with no more than lower secondary education—have also experienced high increases in unemployment across the SEE6 region. (See Spotlight 1 for a discussion of youth unemployment.) 18  |  I. Recent Developments BRITTLE RECOVERY Fiscal Pressures Not Abating While fiscal deficits fell in 2013, the fiscal thanks to tighter control of expenditures. The situation in SEE6 is not sustainable unless average unweighted10 fiscal deficit declined to countries tackle structural rigidities in 3.8 percent of GDP in 2013 from 4.3 percent their expenditures. On average, SEE6 of GDP in 2012 (Figure 19). With sluggish countries reduced their fiscal deficits in 2013 growth, deflationary pressures and the shift toward external demand driven growth, Figure 19: Fiscal Deficits revenues came under pressure, falling by an % of GDP average of 0.5 percent of GDP. But tighter 8 spending, falling by 1 percent of GDP on 7 average, more than compensated the revenue 6 drop. 5 Most countries have seen declines in 4 revenue as a share of GDP (Figure 20) and 3 international trade taxes have performed 2 especially badly. Receipts from international 1 trade taxes declined by an average of 0.5 0 ALB BIH KOS MKD MNE SRB SEE6 EU11 percent of GDP between 2009 and 2013, JJ 2011 JJ 2012 JJ 2013 associated with shrinking imports (Figure 21). Source: National authorities and World Bank staff calculations. Albania and Montenegro were hit especially Figure 20: Change in Revenues, 2009–13 Figure 21: Average Contribution Towards Change in Revenues % of GDP % of GDP, selected revenue sources: 2009–12 1.5 0.3 0.21 1.0 0.2 0.17 0.14 0.5 0.1 0.04 0 0.01 0 -0.5 -0.02 -0.1 -0.06 -1.0 -0.12 -0.2 -0.16 -1.5 -0.3 -0.28 -2.0 -2.5 -0.4 -3.0 -0.5 -0.45 e T * &S * y tio ial S l ce c s es rol ert VA ain rad PIT CIT cis ibu Soc rvi i Ot ns s rG se pec ay p Gr -3.5 ’l t Pro Ex rp he Int he Ot ntr SRB ALB KOS MKD MNE BIH SEE6 EU11 co Source: National authorities and World Bank staff calculations; *PIT and Source: National authorities and World Bank staff calculations; *PIT and CIT exclude BiH, where it is difficult to separate these two income taxes. CIT exclude BIH, where it is difficult to separate these two income taxes. 10 All average figures presented in the fiscal section of this report are unweighted. I. Recent Developments  |  19 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 hard by falling VAT receipts, suffering declines Increases in excise tax rates and external by 0.5 percent of GDP and over 1 percent of grants have helped minimize the revenue GDP respectively relative to 2009 levels as a shortfalls. Excise revenue increased by an result of slow or negative economic growth. average of 0.2 percent of GDP between 2009 Only in Bosnia and Herzegovina did revenues and 2012. However, with products such as increased slightly largely due to the success of cigarettes still significantly cheaper across the the Indirect Tax Authority. region than in Western Europe, there may be some further scope to raise these revenues while However, changes in revenue from trade improving other public policy outcomes (e.g. taxes have been driven by long-term health through reduced smoking). An increase trends. Taxes on international trade have in grants of 0.2 percent of GDP, including EU declined continuously since 2006 (Figure Instrument for Pre-Accession (IPA) funds also 22). Stabilization and Association Agreements helped to close the shortfall. (SAAs) with the EU concluded between 2007 and 2013 required SEE6 countries to lower SEE countries face key fiscal challenges, trade barriers, reducing international trade tax stemming from structural rigidities in public receipts. Taxes on international trade made up expenditures. The public sector wage bill, in 5 to 6 percent of all revenues in 2006 but their part reflecting the large size of the public share had fallen to around 2 percent by 2012 sector, crept up from an average of 8.9 percent (Figure 23). Only in Kosovo, which has not of GDP in 2008 to 9.7 percent in 2012. It Figure 22: Taxes on International Trade Figure 23: Trade Taxes as % Total Revenue % of GDP % of total revenue 4.0 12 3.5 10 3.0 8 2.5 2.0 6 1.5 4 1.0 2 0.5 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 ALB BIH KOS MKD MNE SRB ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB JJ 2006 JJ 2013 Source: National authorities and World Bank staff calculations. Source: National authorities and World Bank staff calculations. yet signed a SAA, have trade taxes held up. In reached well over 11 percent of GDP in Bosnia all countries that have signed SAAs, trade tax and Herzegovina, Montenegro and Serbia, revenues began to fall in anticipation of the taking up an average of 26.2 percent of total agreement. expenditures. Kosovo, which previously had a well-contained wage bill, also rapidly increased 20  |  I. Recent Developments BRITTLE RECOVERY its wage bill—from 5.9 percent of GDP in 2008 increase went largely to the top 60 percent of to 8.4 percent in 2012 and further with recent the population, failing to reach the neediest. public sector wage increases. Only Albania and FYR Macedonia have succeeded in limiting Capital expenditures continued to decline public sector salaries with spending falling from in 2013. Capital expenditures were below 6.1 to 5.1 percent of GDP between 2008 and 4 percent of GDP in the end of 2013 in FYR 2012 in Albania and from 8.1 to 7.5 percent Macedonia, Montenegro, and Serbia. Despite of GDP between 2009 and 2012 in FYR notable infrastructure needs, all SEE countries Macedonia. However, public sector wages are (except Kosovo) cut capital spending as a share set to increase in FYR Macedonia in October of GDP between 2008 and 2013, while they 2014 after being frozen since 2009. increased the wage bill and social transfers (Figure 24). Even in Kosovo, the increase in As noted in the previous edition of this capital expenditure was largely inefficient, Regular Economic Report, spending on concentrated on one large road construction pensions and social benefits remains high project whose economic rates of return might and often not targeted toward the neediest. not be high. Recent increases in war veterans’ benefits (which are not targeted to poor groups) in Kosovo are a The 2014 budget plans suggest continued move in the wrong direction. Pensions in FYR efforts to consolidate the fiscal positions by Macedonia were increased across the board by the SEE6 governments. SEE6 fiscal deficits are 5 percent in March 2013 and by an additional projected to increase by an average of 0.3 percent 5 percent in March 2014 and, in its electoral of GDP in 2014. But the average masks two program, the Government announced that it groups of countries in SEE6. According to will continue increasing pensions and social their budgets, deficits are projected to decline benefits each year. In Albania, a recent pension in Bosnia and Herzegovina, Kosovo and FYR Figure 24: Capital Expenditure Figure 25: Contribution Toward Change in Deficit, 2013–14 % of GDP % of GDP 12 4 10 3 2 8 1 6 0 4 -1 2 -2 0 -3 ALB BIH KOS MKD MNE SRB SRB ALB KOS MKD MNE BIH SEE6 EU11 JJ 2008 JJ 2013 JJ Revenue contribution JJ Expenditure contribution QQ Change in deficit Source: National authorities and World Bank staff calculations. Source: National authorities and World Bank staff calculations. I. Recent Developments  |  21 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Macedonia as revenues pick up and spending is clearance effort. Serbia’s projected deficit in tightened (Figure 25). However, meeting these 2014 is higher than in 2013 because of one-off targets may be challenging. In FYR Macedonia, measures related to bank recapitalization and the authorities exhausted 61 percent of the severance pay budgeted for the SOE reform. If budgeted deficit for 2014 in the first quarter these expenditure measures were excluded, the of the year and a similar first quarter outturn in fiscal deficit in 2014 would be lower. Further 2013 led to an increase in the deficit. In Kosovo, expenditure consolidation measures, tackling the authorities have committed to maintain the some structural rigidities (e.g. public wages, deficit in line with the fiscal rule of 2 percent pensions) are currently being considered in of GDP (down from 3 percent in 2013), but both Montenegro and Serbia, which would large increases in public service salaries and war narrow the planned deficit. veteran benefits means reaching this target may Figure 26: Public Debt and Guarantees % of GDP 8 7 6 5 4 3 2 1 0 e e e e e e e 12 12 12 12 12 12 12 f f f f f f f 13 13 13 13 13 13 13 14 14 14 14 14 14 14 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 ALB BIH KOS MKD MNE SRB 20 SEE6 JJ Public debt JJ Guarantees ▬▬ 40% threshold ▬▬ 60% threshold Source: National authorities and World Bank staff calculations. prove difficult. In Montenegro, further fiscal Reflecting weak growth recovery and delayed consolidation is being envisaged in line with fiscal consolidation, public debt continued the fiscal rule that targets 3 and 60 percent of to rise in 2013 and is projected to increase GDP of deficit and debt ceilings, respectively. further in 2014. Average public debt excluding However, achieving the fiscal targets may guarantees rose from 41.9 percent of GDP in prove difficult given the planned infrastructure 2012 to 44.7 percent in 2013 as SEE countries projects. The other group of countries had to borrow to fund fiscal deficits (Figure comprises Albania and Serbia. Revenues are 26). Public debt is projected to increase further projected to increase in Albania and Serbia in 2014 in line with rising fiscal deficits. Public on the back of tax policy changes and efforts debt excluding guarantees is already over to improve tax collections. But Albania’s 60 percent of GDP in Albania and approaching fiscal deficit in 2014 is projected to increase because of a large (2.5 percent of GDP) arrears 22  |  I. Recent Developments BRITTLE RECOVERY that level in Montenegro and Serbia11. An Table 2: Sovereign Debt Ratings expensive highway, estimated to cost around Dec Dec Dec Dec Feb a quarter of GDP in Montenegro, is planned 2010 2011 2012 2013 2014 to be financed through new borrowing. Recent ALB B+ B+ B+ B B research suggests that fast-increasing debt is as BiH B+ B B B B likely as high debt to slow economic growth MKD BB BB BB BB- BB- (see Pescatori et al., 201212). MNE BB BB BB- BB- BB- SRB BB- BB BB- BB- BB- Government guarantees continued to add Source: Standard and Poor. fiscal risk to the already strained fiscal situation in the course of 2013. Guarantees consolidation”. It is possible to have fiscal added an estimated 5.4 percent of GDP to consolidation that eliminates waste and controls public sector debt on average in 2013. While the public sector wage bill; but maintains this is down slightly from the 5.8 percent productive spending on infrastructure estimated in 2012, governments need to bottlenecks, targeted spending on the poor exercise caution when guaranteeing private and appropriate spending for labor market sector or SOE debt. These burdens come on reactivation programs for targeted groups. top of implicit guarantees such as pensions, Reversing current policy tendencies to cut which are rapidly rising in aging economies. capital spending and boost public sector wages could help to support economic growth. SEE6 countries’ credit ratings remained largely stable in 2013. With mixed fiscal Smart fiscal consolidation for fiscal performance, the region suffered only two sustainability over the medium to long term downgrades. Standard and Poor downgraded will require action on several fronts. First Albania’s credit rating in December 2013, and foremost, it will require continued fiscal largely owing to the rising public debt consolidation efforts to ensure that there is a (Table 2), although this has come partly as policy space to counter downturns and bring an acknowledgement of large arrears, and down public debt levels. But the sources efforts to account for them and to clear them of expenditure reductions matter. Many are welcome. FYR Macedonia’s rating was SEE countries have space to reduce public downgraded in May 2013. expenditure, particularly in the public wage bill and poorly targeted social protection benefits. Keeping public debt at sustainable levels Second, structural reforms in the economy more and ensuring public spending helps to broadly (for example, improvements in the drive growth will require “smart fiscal business climate) can help to boost the private sector, with secondary benefits for public sector revenues. Third, growth-promoting investment 11 IMF research proposes debt thresholds of 60 percent of GDP through enhanced utilization of the EU for advanced economies and 40 percent for emerging markets to manage the risk of debt crises. See e.g. Baldacci et al. (2013). Instrument for Pre-Accession Assistance (IPA) Available from: http://www.imf.org/external/pubs/ft/wp/2013/ funds would create much desired fiscal space. wp13238.pdf 12 http://www.imf.org/external/pubs/ft/wp/2014/wp1434.pdf I. Recent Developments  |  23 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Falling and Low Inflation Inflation declined notably across the SEE6 Downward pressures on prices continued region in the course of 2013. As the effects in most countries in early 2014. Despite of increases in food and administered prices as deflationary pressures in Bosnia and well as taxes dissipated, the region experienced Herzegovina and Montenegro , along with a dramatic drop in inflation rates, which turned further inflation slowdown in Kosovo and FYR into deflation in some countries (Figure 27). Macedonia, annual increases in consumer prices The four countries that peg their currencies in Serbia and Albania kept inflation in SEE6 to the euro (via currency boards, hard pegs, or in the first two months of 2014 unchanged unilateral euroization) recorded lower inflation compared to December 2013 (at 1.2 percent). than Serbia and Albania with full monetary policy flexibility. At end-of-2013 there was Falling world food prices, in particular, deflation in Bosnia and Herzegovina (where drove much of the drop in the CPI inflation CPI fell by 1.2 percent) and unusually low in SEE6 in 2013 and the beginning of FY14 inflation in Serbia (2.2 percent). The difference (Figure 29). At end-2013, Serbia recorded the  between inflation in SEE6 and in EU11 and largest fall among the SEE6 in CPI inflation EU15 came down from about 5 percentage compared to December 2012 (by 10 percentage points at the end of 2012 to only half of points) because of the drop in food prices. The percentage point in February 2014 (Figure 28). exception was FYR Macedonia, where inflation developments were driven by a slowdown in global energy prices and the waning effect of Figure 27: CPI Inflation Figure 28: Regional CPI Inflation Comparison percent (y-o-y) percent (y-o-y) 20 8 7 15 6 10 5 4 5 3 2 0 1 -5 0 1 12 2 2 2 2 2 13 3 3 3 3 3 14 2 13 3 3 3 3 3 14 c-1 r-1 -1 g-1 t-1 c-1 r-1 -1 g-1 t-1 c-1 c-1 r-1 -1 g-1 t-1 c-1 b- b- b- b- b- Jun Jun Jun Oc Oc Oc Ap Ap Ap De Au De Au De De Au De Fe Fe Fe Fe Fe ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ SEE6 ▬▬ SEE6 ▬▬ EU11 ▬▬ EU15 Source: National statistical offices and World Bank staff calculations. Source: National statistical offices and World Bank staff calculations. Note: SEE6 is weigthed average. Note: Regional inflations are weigthed averages. 24  |  I. Recent Developments BRITTLE RECOVERY Figure 29: Food Price Inflation Figure 30: Energy Price Inflation percent (y-o-y) percent (y-o-y) 20 20 15 15 10 10 5 5 0 0 -5 -5 -10 1 12 2 2 2 2 2 13 3 3 3 3 3 14 1 12 2 2 2 2 2 13 3 3 3 3 3 14 c-1 r-1 -1 g-1 t-1 c-1 r-1 -1 g-1 t-1 c-1 c-1 r-1 -1 g-1 t-1 c-1 r-1 -1 g-1 t-1 c-1 b- b- b- b- b- b- Jun Jun Jun Jun Oc Oc Oc Oc Ap Ap Ap Ap De Au De Au De De Au De Au De Fe Fe Fe Fe Fe Fe ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ SEE6 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ SEE6 Source: National statistical offices and World Bank staff calculations. Source: National statistical offices and World Bank staff calculations. Note: SEE6 is weighted average. Note: SEE6 is weighted average. domestic regulated price increases earlier in Figure 31: Output Gaps in SEE6 2012 (Figure 30). % of potential GDP 10 In this low-inflation environment, SEE6 8 central banks engaged in moderate loosening 6 of monetary policy. Sluggish domestic demand 4 in 2013 left much spare production capacity in 2 these economies, contributing to a negative 0 output gap (Figure 31). To support liquidity -2 and enhance access to finance, central banks -4 in Albania, FYR Macedonia13 and Serbia cut their key interest rates in 2013 by 1, 0.5 and -6 2008 2009 2010 2011 2012 2013 1.75 percentage points, respectively (Figure ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE ▬▬ SRB 32). Given the limited scope of their monetary Source: IMF WEO and Staff country reports. Note: Estimates for Kosovo are not available. policy, Kosovo, and Montenegro14 reduced the reserve requirements of the banks relative to the pre-crisis level mainly to ease financing: to Herzegovina, and to 10 percent in Kosovo. As 9.5 percent and 8.5 percent (depending on the a result, the monetary aggregate M2 slightly maturity of the instruments) in Montenegro, increased in SEE6 in the second half of 2013, 10 percent and 7 percent in Bosnia and when the real money stock in December 2013 was some 6 percent higher than in March 2009 (Figure 33). However, the monetary expansion 13 FYR Macedonia’s National Bank also employed nonstandard monetary measures to enable credit support for the corporate in EU15 at 24 percent (compared to March sector, as well as to ensure inflow of long-term foreign capital into the domestic economy. 2009) was much higher than in either SEE6 or 14 Kosovo and Montenegro have unilaterally adopted the euro as EU11. their sole legal tender, while Bosnia and Herzegovina runs a euro- based currency board. I. Recent Developments  |  25 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure 32: Official Policy Rates Figure 33: Real Broad Money Supply percent 2009:Q1=100 20 125 18 120 16 115 14 12 110 10 105 8 100 6 95 4 2 90 0 85 8 8 9 9 0 0 1 1 2 2 3 3 4 9 9 0 0 1 1 2 2 3 3 -0 -0 -0 -0 -1 -1 -1 -1 -1 -1 -1 -1 -1 -0 -0 -1 -1 -1 -1 -1 -1 -1 -1 Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 ▬▬ ALB ▬▬ MKD ▬▬ SRB ▬▬ Eurozone (ECB refinance rate) ▬▬ SEE6 ▬▬ EU11 ▬▬ EU15 Source: ECB, National statistical offices. Source: IMF IFS, ECB, Eurostat, National central banks. Further easing should be pursued with caution in SEE6. Given deflationary pressures, still large output gaps, and the fact that money supply only recently started growing faster than nominal income, there appears to be room for further easing in the countries with monetary flexibility. However, if pursued, monetary easing should be gradual. Moreover, pressure on exchange rates in the countries with flexible exchange rates may limit the room for policy easing. In the four countries with pegged currencies there are limited monetary policy tools to overcome deflationary pressures. This may impact their public debt through lower nominal GDP and potentially lower revenues. In addition, in a deflationary environment, households and firms may see their debts increase as a share of their income, potentially exacerbating the problem of non-performing loans. 26  |  I. Recent Developments BRITTLE RECOVERY Stable, Albeit Fragile, Financial Sector The SEE6 financial sector remained broadly the region, reflecting the ongoing firming stable, albeit fragile, in 2013 and the up of the European banks’ balance sheets, beginning of 2014. Its performance across an which is likely to continue amid the Euro array of financial indicators suggests no recent Area banking sector stress tests (Figure deterioration: 35).15 However, the risk of deleveraging remains as some Greek, Slovenian or • Funding conditions for SEE6 countries Austrian parent banks scale back their improved in the second half of 2013 and presence in the face of continued market foreign banks’ deleveraging continued and regulatory pressures. The European (Figure 34). Notwithstanding increased Central Bank (ECB) asset quality market volatility and tightening global reviews and stress tests add an element of liquidity conditions during Q3 2013, uncertainty. foreign funding to SEE6 continued to • Bank profitability declined in 2013 in decline (with Q4 2013 outcome likely most of the countries and is far below following the same path). Credit Default the pre-crises levels (Figure 36). Three Figure 34: Funding and Funding Costs for Figure 35: CDS Spreads of SEE6 SEE6 million, Euro basis points basis points 3,000 1,000 1,400 900 2,000 1,200 800 1,000 700 1,000 600 0 800 500 -1,000 400 600 -2,000 300 400 200 -3,000 200 100 -4,000 0 0 1 1 1 1 2 2 2 2 3 3 3 1 1 1 1 2 2 2 2 3 3 3 3 4 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 JJ Change in BIS reporting banks external position vis-à-vis SEE6 ▬▬ ALB ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ Parent bank CDS spread (rhs) ▬▬ Sovereign CDS spread (rhs) Source: Bloomberg, Bank for International Settlements (BIS) and World Bank staff calculations. Note: *Amounts are exchange rate adjusted and SEE6 countries includ: Albania, Bosnia and Herzegovina, FYR Macedonia, Montenegro and Serbia. ** Banks included: Raiffeisen Bank, Erste Bank, Banca Intesa, UniCredit Bank, Societe Generale, National Bank of Greece (NBG) and Alpha Bank. *** Countries included: Albania, FYR Macedonia, Montenegro and Serbia. Swaps (CDS) spreads reached their lowest 15 According to the latest ECB data, a sharp drop in euro area banks’ levels since the crisis for most of the SEE6 aggregate balance sheets in December 2013 (Figure 14) was in part driven by a decline in their external assets, which presumably sovereign debt and for banks operating in included a decline in their funding to emerging markets. I. Recent Developments  |  27 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure 36: Return on Assets (ROA), quarterly Figure 37: Loan-to-Deposit Ratios averages percent percent 3.0 180 2.5 160 2.0 140 1.5 120 1.0 100 0.5 80 0 60 -0.5 -1.0 40 -1.5 20 -2.0 0 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ 2012 JJ 2013 QQ Average (2006–2008), quarterly JJ Dec-12 JJ Dec-13 QQ Peak level since 2006 Source: National authorities and World Bank staff calculations. Source: National authorities and World Bank staff calculations. Figure 38: Liquidity Ratio Figure 39: Capital Adequacy Ratio percent percent 45 25 40 35 20 30 15 25 20 10 15 10 5 5 0 0 9 9 0 0 1 1 2 2 3 3 -0 -0 -1 -1 -1 -1 -1 -1 -1 -1 ALB BIH KOS MKD MNE SRB Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 ▬▬ ALB ▬▬ BIH ▬▬ MKD ▬▬ MNE ▬▬ SRB JJ Dec-12 JJ Dec-13 QQ Average (2006–2008), quarterly Source: National authorities and World Bank staff calculations. Note: Data for Serbia for -Average 2006–2008 quarterly Capital Adequacy Ratio, refers to 2008 only. Due to the accounting harmonization with the IFRS, data for Montenegro is not comparable. of the six countries saw a decline in the six countries in the region (Figure 37). profitability of their banks, with Bosnia Serbia further reduced its loan-to-deposit and Herzegovina recording the biggest ratio and its banks increased their liquidity fall. Bank profitability only increased in considerably in the past two years, but it FYR Macedonia and Montenegro, after still has the highest ratio in the region, being negative in 2012, while Kosovo at 131 percent at end-2013. Bosnia and had the highest bank profitability in the Herzegovina and Montenegro are the region. other two countries with loan-to-deposits • Loan-to-deposit ratios improved in 2013, ratios higher than 100, standing at 114 at but continued to be high in three of the end 2013. 28  |  I. Recent Developments BRITTLE RECOVERY • Regional banks remained liquid and balance sheets and contain costs added well capitalized. Overall, liquidity in the pressure on lending and slowed credit growth banking system in the region is adequate, to a crawl across SEE6 in 2013 (Figure 41). despite the decline in the liquidity in many Credit growth slowed in Albania, Bosnia other countries (Figure 38). However, and Herzegovina and Kosovo, with Kosovo individual banks in some countries may registering the largest decline of the three. In face difficulties. On average, bank capital Serbia, credit growth turned negative in 2013 adequacy ratios across the region are as a result of contraction in corporate lending. reasonably strong (Figure 39). However FYR Macedonia and Montenegro were the each country has a few banks struggling to only countries where credit growth in 2013 meet their capital requirements. accelerated; in Montenegro due to transfer of non-performing loans back from off-balance Against this backdrop, two key challenges sheets. need immediate action by the authorities: resuming credit growth in a sustainable manner, Second, NPLs increased to historically high especially corporate lending; and reversing the levels by end-2013. NPLs increased more than growth curve of non-performing loans (NPLs). three-fold from an average of 5 percent in the pre-crises period to an average of 16 percent First, across the region, despite the recovery at end-2013. Albania and Serbia registered signs, corporate credit growth declined the highest level of NPLs at end-2013, either in 2013 leading to a largely credit-less near or at its historical peak. Montenegro also recovery. Rapidly rising NPLs (Figure 40), posted a high level of NPLs, but contrary to the introduction of tighter credit underwriting Albania and Serbia, it saw a decline from the standards, and banks’ efforts to clean their peak of 25 percent in early 2011 to 17.5 percent Figure 40: Non-performing Loans Figure 41: Credit Growth Rates % of total loans percent 30 60 25 50 40 20 30 15 20 10 10 5 0 0 -10 ALB BIH KOS MKD MNE SRB ALB BIH KOS MKD MNE SRB JJ Dec-12 JJ Dec-13 QQ Peak since 2008 ‹‹ Pre crisis level (end 2007) JJ 2009 JJ 2010 JJ 2011 JJ 2012 JJ 2013 QQ Avg. growth 2003–2005 Source: National authorities and World Bank staff calculations. Source: National authorities and World Bank staff calculations. Note: Data for pre-crisis NPL level (2006–2008) for Serbia refers to end of Note: Average growth rate for the period 2003–2005 for Albania 2008 level only. and Serbia, and for the period 2004–2005 for FYR Macedonia and Montenegro. Due to the accounting harmonization with the IFRS, data for Montenegro for 2010 onwards is not comparable I. Recent Developments  |  29 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 in 2013.16 Bosnia and Herzegovina also saw an increase in NPLs to an historic high of 15 percent (despite the “bulk sale” of bad loans in 2011 and 2012), while NPLs in FYR Macedonia peaked at 12 percent in Q2 2013 before declining slightly in the second half of the year. NPLs in Kosovo were also at peak levels, albeit far below the regional average. If they are not reduced, NPLs will continue burdening banks’ balance sheets, result in high collection costs and slowdown the recovery process as banks have less lending capacity and become more risk-averse(for expended discussion on NPLs, see Spotlight 2). The time for the authorities to deal decisively with the challenge of rising NPLs is now (see Spotlight 2). Even though the high levels  of NPLs have not caused serious instability of the financial sector as these loans appear to be well provisioned and backed by adequate bank capital, not tackling this risk head-on may further destabilize the fragile banking sector and threaten the recovery process. 16 The decline came largely as a result of “bulk sales” of bad loans in 2011 and 2012. 30  |  I. Recent Developments BRITTLE RECOVERY II. Prospects Near-Term Growth Prospects and Medium-Term Outlook The SEE region is projected to grow at a SEE6 economic growth prospects in 2014 rate of 1.9 percent in 2014. The projection hinge upon a sustained recovery of external for growth in SEE6 is slightly higher (by demand. The positive growth since mid- 0.1 percentage point) and broadly in line with 2013 and the still accommodative monetary the SEE6 RER December 2013 report forecast. conditions of the Euro Area are likely to Growth is expected to remain positive in 2014 continue to help SEE6 to increase their in all SEE6 countries. It is likely to firm up in exports. However, economic activity in SEE6 is FYR Macedonia and Montenegro, to accelerate dampened by weak domestic demand. Serbia, in 2014 in Albania, Bosnia and Herzegovina, the largest of the SEE6 economies, appears to and Kosovo and to slow down in Serbia. be headed toward a sizeable fiscal consolidation Serbia remains the slowest-growing economy to bring its public debt to a sustainable level and Kosovo fastest (Table 3). SEE6 economic and this is likely to act as a drag on economic growth in 2014 is projected to be below EU11 activity. In contrast, economic growth in the growth rates (1.9 versus 2.6 percent). other five SEE countries is expected to firm up in 2014 and exceed the pace of economic Table 3: Real GDP Growth and Projections expansion of 2013, in line with expected stronger external demand, some modest percent 2012 2013e 2014f 2015f declines in unemployment and improved credit Albania 1.3 0.4 2.1 3.3 conditions. Albania’s growth is projected at a Bosnia and -1.1 1.8 2.0 3.5 Herzegovina 2.1 percent as the planned clearance of payment Kosovo 2.7 3.0 3.5 3.5 arrears by the government is expected to inject much needed liquidity to the private sector FYR Macedonia -0.4 3.1 3.0 3.5 and support growth. The economies of FYR Montenegro -2.5 3.5 3.2 3.5 Macedonia, Kosovo, and Montenegro have Serbia -1.7 2.5 1.0 1.5 some momentum in construction, services, and SEE6 -0.7 2.2 1.9 2.6 tourism, but their share in the regional SEE6 Memo item: economy is too modest to change the overall Euro Area -0.7 -0.4 1.2 1.7 regional picture. EU11 0.8 1.3 2.6 2.9 Source: World Bank staff projections. Note: Weighted average. Economic policies can be instrumental for growth in the near- and the medium-term in II. Prospects  |  33 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 SEE6. On the fiscal side, sustained reform effort The pace of the Euro Area recovery could is needed to address structural rigidities in the be weaker owing to disinflation or even budgets of SEE6. Priorities include: changes in deflation. This would reduce the export the composition of public expenditure toward growth that has been so important to investment and away from wages, public the nascent economic recovery of SEE6 expenditure targeting and prioritization as well countries. as improvements in revenue collection and the (ii) The pace of rising global interest rates: In broadening of the tax base, among others. On light of the gradual tapering by the United the monetary policy side, with regional inflation States Federal Reserve, developing and at a very low 1.2 percent and big output gaps emerging market economies, including remaining, some scope for short-term easing of the SEE6, are entering a period of expected monetary conditions exist, especially in those global financial tightening in the medium countries where deficits have begun to decline. term. This could have implications for However, caution needs to be exercised in funding inflows to the region. Global risks the economies with flexible exchange rates to are discussed in Box 3. ensure that these do not come under pressure. (iii) The potential geo-political ramifications In terms of financial sector policies, addressing of the ongoing Russia-Ukraine conflict: the high NPLs would be critical to ultimately The escalation of the political crisis will restoring the growth of credit and supporting introduce new risks for Europe. While the entrepreneurship and job creation. SEE6 linkages with Russia and Ukraine are limited, further intensification of SEE6 growth in 2015 is expected to these geo-political tensions would have accelerate to 2.6 percent on average. All six inevitable direct (through trade and SEE economies are expected to contribute to financial channels) and indirect (though the increase in growth rates as external demand second-round effects via Europe) firms up and domestic demand begins to implications for economic growth in recover. Albania, Bosnia and Herzegovina, the SEE6 region. Broader risks related Kosovo and Serbia are all projected to have to contagion and negative investor higher or the same growth in 2015 than in confidence may also appear as a result of 2014. In 2015, SEE6 economies are projected the Russia-Ukraine conflict. to grow slightly slower than the average for (iv) Insufficient effort in tackling remaining the EU11 countries (2.6 percent compared to structural weaknesses: “Reform fatigue” 2.7 percent growth for EU11). may delay implementation of policies designed to improve, for example, the There are significant downside risks to business climate or address weaknesses the macroeconomic outlook for the SEE6 in labor markets or reduce the large region. These risks, both external (see Box 3) structural fiscal deficit or restructure the and internal, are related to: state-owned enterprise sector. In addition, the fiscal challenges to stabilize and reduce (i) Deflationary risks in the Euro Area leading public debt in several countries may to weak Euro Area economic recovery: appear daunting. Also, lack of progress on 34  |  II. Prospects BRITTLE RECOVERY Box 3: Global Outlook and Risks The world economy is projected to accelerate this year, with high-income economies appearing to finally turn the corner five years after the global financial crisis. Global GDP growth is projected to expand by 2.9 percent in 2014 (versus 2.4 percent in 2013) and 3.4 percent and 3.4 percent in 2015 and 2016. Most of the acceleration is expected to come from high income countries, as the drag on growth from fiscal consolidation and policy uncertainty eases and private sector recoveries gain a firmer footing. High-income country growth is projected to strengthen from 1.3 percent in 2013 to 2.0 percent this year and 2.4 percent in each of 2015 and 2016. Growth in developing countries is projected to pick up modestly remaining flat at 4.9 percent. With most regions operating at close to capacity, however, growth accelerations in developing countries are expected to be muted going forward, barring substantial supply-side reforms that alleviate structural bottlenecks and raise productivity growth. Stronger high-income growth and import demand will be an important tailwind for developing countries’ exports, which should help compensate for tighter global financial conditions. Downside risks for developing countries remain closely tied to headwinds from international financial markets, set against a backdrop of domestic weaknesses. Tightening global financial conditions over the next five years as monetary policy is normalized in high income economies imply weaker financial flows and rising costs of capital. If interest rates rise too rapidly or there are sharp pullbacks in capital flows, economies with large external financing needs or rapid expansions in domestic credit in recent years could come under considerable stress. The relatively smooth progress of the US taper so far and the fact that two bouts of financial turmoil since mid-2013 have not yet triggered severe adjustments in developing countries is a positive, suggesting that tapering-related risks have diminished compared to last year. Nevertheless, the adjustment to tighter global financial conditions is still unfolding, and market sentiment could become unsettled around key decision points related to the taper, for instance the timing of the first policy rate hikes in the US. Risks of currency mismatch from high levels of external debt (the “original sin” that felled them in past crises) are not relevant for most developing countries barring developing Europe and Central Asia. Nevertheless, high levels of foreign ownership in domestic bond markets in some economies expose them to shifts in sentiment. Institutional investors, who hold large stocks of local currency debt, have so far maintained their exposures during in the last two episodes of financial market volatility. Still, a further bout of global risk aversion in an environment where the credit ratings of several developing countries are still on a negative outlook could eventually lead to pullbacks from these markets, with severe implications for access to and costs of capital. the resolution of NPLs, and public sector heightened social tensions, as seen most arrears to suppliers could adversely impact recently in Bosnia and Herzegovina. credit recovery and growth prospects. (v) Socio-political tensions: Albeit to a (vi) Weather related risks: The impact of the different degree across the SEE6, high recent floods on economic activity in levels of unemployment, ongoing SOE Bosnia and Herzegovina and Serbia is not restructuring efforts and elections in known yet, but it will likely put further Bosnia and Herzegovina and Kosovo downward pressure on the recovery in are among the factors which may trigger these two countries in 2014. Agriculture is II. Prospects  |  35 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 especially likely to be hit and mining as well as infrastructure may also be harmed. On the other hand, reconstruction efforts may partly counteract the negative effect of the floods. In addition, the increased rainfall will ensure full reservoirs, benefitting hydro-power generation (which suffered during droughts in 2012). These external and domestic risks, if they materialize, will affect negatively the prospects for growth in the SEE6 countries and slow the nascent economic (Figure 42). In an extreme case of major  deterioration of economic conditions driven by the materialization of above risks, SEE6 output growth in 2014 would less than halve (to 0.6 percent) of the baseline projection (of 1.9 percent). In 2015, growth would drop by a third (to 1.7 percent) from the baseline (2.6 percent). Figure 42: SEE6 Real GDP Growth Rate under Baseline and Low Case Scenarios percent 3.0 2.5 2.0 1.5 1.0 0.5 0 2014 2015 JJ Baseline JJ Low Source: World Bank staff. 36  |  II. Prospects BRITTLE RECOVERY Challenging Long-Term Convergence Living standards in SEE are considerably with the EU from 24 percent of average EU below those of the EU and there has been incomes in 2000 to 31 percent in 2013—an only modest catch-up since 2000. Moreover, average convergence of around 0.5 percent per the double-dip recession slowed the progress year (Figure 44). This performance contrasts achieved prior to the crisis. Measured in with that of the EU11 countries, whose average purchasing power terms, average incomes in incomes rose from 30 to close to 40 percent SEE6 in 2013 stood at less than a third of the of the EU average over the period, at a faster EU (Figure 43). In addition, with an average convergence rate of 0.7 percent per year. income over 20 percent lower than that in the The “EU convergence machine” seems to EU11, SEE6 countries remain worse off than be accelerating income convergence of new their Eastern European peers that joined the EU member countries faster than those who EU. remain outside, even as they become candidate countries.17 The SEE6 have narrowed their income gap with the EU between 2000 and 2013. Over Despite a solid pace of income convergence this period, average per capita growth rates prior to the global financial crisis, the SEE6 were just under 3 percent per year, compared catch-up with the EU income levels has been Figure 43: 2012 GDP Per Capita Figure 44: SEE GDP Per Capita (PPP) as % EU Average PPP, 2005 USD percent 30,000 90 25,000 80 70 20,000 60 15,000 50 10,000 40 5,000 30 0 20 ALB BIH KOS MKD MNE SRB SEE6 EU11 EU 2000 2002 2004 2006 2008 2010 2012 ▬▬ SEE6 as percent of EU11 ▬▬ SEE6 as percent of EU Source: World Development Indicators. Source: World Development Indicators. 17 Raiser, Martin; Gill, Indermit S. 2012. Golden Growth: Restoring with 1.1 percent in the EU and 3.2 percent in the Lustre of the European Economic Model. Washington, DC: EU11 countries. As a result, despite the large World Bank. World Bank. 2012. EU11 Regular Economic Report No. 25 Special Topic. Washington, DC: World Bank. © World income differential, SEE6 narrowed its gap Bank. II. Prospects  |  37 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 on hold since then. SEE growth performance productive potential and competitiveness, has especially lagged their Eastern European enhancing skills and labor productivity, and peers during and after the global crisis. Despite strengthening institutions would ultimately being over 20 percent lower, SEE living contribute positively to income growth and standards rose slower than EU11 countries convergence. between 2009 and 2013, with their average incomes falling from 81 to 78 percent of EU11 Figure 45: Income Convergence countries. The pace of income convergence of GDP per capita, PPP, 2005 USD the SEE6 prior to 2009 was faster than after the 40,000 crisis (Figure 44). 35,000 30,000 Reaching EU living standards will require 25,000 decades of sustained effort by SEE6 countries, 20,000 and improved policy, institutional and 15,000 economic performance. Even with economic 10,000 growth of 6 percent per year, it would take ten 5,000 years to catch up with EU11 countries and over 20 years to reach EU average living standards 0 2000 -03 -06 -09 -12 -15 -18 -21 -24 -27 -30 -33 2036 (Figure 45). At more realistic growth rates of ▬▬ EU (@1%) ▬▬ EU-11 (@3.5%) ▬▬ SEE (@2%) 4.5 percent—though still significantly higher ▬▬ SEE (@4.5%) ▬▬ SEE (@6%) Source: World Bank staff. than recent average growth—it would take SEE over 20 years to reach EU11 living standards and convergence with the EU as a whole would Boosting incomes in the medium to long- be a distant prospect. term with the aim of converging with EU standards will mean not only maintaining the What factors will likely drive the economic pace of reforms—but also converting reforms convergence machine in SEE6? A recent benefits into robust and equitable economic analysis focuses on EU member countries and growth. Both of these are proving challenging. shows that expanding the growth potential The reform pace appears to have slowed during through structural reforms in a stable the financial crises. Countries will need to take macroeconomic environment drives strong advantage of the economic rebound to relaunch income convergence.18 Translated to the SEE6, the reform and convergence processes. There is it means that removing structural rigidities in evidence suggesting that improvements in the the macroeconomic policy mix (as discussed business climate should be broad rather than in the previous part of this report), increasing targeted toward specific sectors, as growth and global integration, improving the economy’s employment creating firms tend to be young and dynamic, but not concentrated in any particular sector.19 Improving trade links in 18 Raiser, Martin; Gill, Indermit S. 2012. Golden Growth: Restoring the Lustre of the European Economic Model. Washington, DC: World Bank. World Bank. 2012. EU11 Regular Economic Report No. 25 Special Topic. Washington, DC: World Bank. © World 19 Arias, O. et al. 2013. Back to Work: Growing with Jobs in Europe and Bank. Central Asia, World Bank, Washington, D.C. 38  |  II. Prospects BRITTLE RECOVERY Box 4: Demographic Challenges to Income Convergence in SEE6 Reform and convergence in SEE6 will be made harder by an aging population. Over time, fewer workers will be able to support an increased retired population. Faster economic growth is required to attract a greater share of the working-age population into the labor market. Creating a business environment that encourages firms to hire and a social environment that encourages working-age people to seek employment will be important. At the same time, governments will need to invest sufficient resources in education to ensure a skilled and productive labor force is available when private sector demand strengthens. The issues associated with these demographic developments are aggravated because SEE6 countries do a poor job of attracting migrants. Instead, the SEE6 are champions in Europe in exporting people. The equivalent of a quarter of the current population (25.44 percent in 2013) of SEE6 countries currently lives outside their home countries. In 1990, the shares of emigrants from SEE6 countries was half of what it is today. Over the last two decades, SEE-6 countries experience a sharp increase in emigration and currently roughly 4.9 million people originating in an SEE6 are counted as a migrant in another country. To the extent that SEE6 economies evolve toward innovation and technologically advanced products, a shortage of skills could constrain economic growth in the region. Creating incentives to bring skilled individuals back may soon become a priority for SEE6 economies. terms of logistics, institutions and regulations to take advantage of these opportunities are will be important to take advantage of the essential to increase the income generation EU market. In addition, governments need capacity of the entire population.20 to provide reliable and streamlined processes that guarantee EU safety standards are met for exporting firms, particularly for agricultural exporters. Improvements in governance standards—including the rule of law—will be closely linked to the EU integration process. But reforms required by the EU will also help to boost economic growth in SEE countries. Such reforms are essential to boost labor demand, reduce unemployment, address the challenges driven by demographic changes (Box 4) and improve prosperity for all in SEE6. Increasing employment is essential to reduce poverty and to bring about shared prosperity in SEE6. Since the major source of income for most households is through selling labor, increasing employment opportunities and 20 World Bank. 2014. Regular Economic Report No5 Special Topic “First Insights into Shared Prosperity,” World Bank, Washington, ensuring that workers have the skills necessary D.C. II. Prospects  |  39 BRITTLE RECOVERY III. Spotlights Spotlight 1. Youth (Un)employment in the Western Balkans Youth employment matters countries with youth unemployment rates of over 40 percent, five are in South East Europe, SEE6 countries have among the highest with only Albania outside this group (Figure levels of youth unemployment in Europe. S1.1). The single worst performer—Bosnia and Youth unemployment rates were hit especially Herzegovina—has a youth unemployment rate hard by the crisis. At 49.2 percent, average of 62.8 percent. Youth unemployment also rose youth unemployment in SEE6 countries is faster during the global financial crisis in SEE nearly twice as high as in EU11 countries than in other countries although this was driven (27.1 percent) and EU1721 countries by a few large countries. Between 2008 and (25.3 percent).22 Of the eight European 2012, the total unemployment rate in the EU Figure S1.1: Youth unemployment rate, Figure S1.2: Change in unemployment rate, 2012 2008–12 percent percentage points Germany 12 Austria Netherlands Denmark Finland Luxembourg Czech Republic 10 Belgium Slovenia Estonia United Kingdom Albania Romania 8 Sweden France Lithuania Poland Cyprus 6 Hungary Bulgaria Latvia Ireland Slovakia Italy 4 Portugal Montenegro Croatia Serbia 2 Spain FYR Macedonia Kosovo Greece Bosnia and Herzegovina 0 0 20 40 60 EU-17 EU-11 SEE-6* JJ Adult unemployment JJ Youth unemployment Source: ILO; World Bank Staff calculations. Source: ILO; World Bank Staff calculations. Note: *Excludes Kosovo due to data availability. Note: *Excludes Kosovo due to data availability. 21 EU17 countries are the EU15 plus Cyprus and Malta. That is: had risen by around 4 percentage points relative Austria; Belgium; Cyprus; Denmark; Finland; France; Germany; Greece; Ireland; Italy; Luxemburg; Malta; Netherlands; Portugal; to its pre-crisis levels, and by 5 percentage Spain; Sweden; and United Kingdom. points in SEE6. Youth unemployment rates 22 Data from 2012 unless otherwise specified, for reasons of comparability. rose twice as fast (Figure S1.2). III. Spotlights  |  43 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Combatting youth unemployment is perhaps future earnings and job prospects, and delay or the highest priority in SEE. Not only has prevent accumulation of valuable on-the-job youth unemployment risen faster and higher skills (ILO, 2012). These “scarring effects” can levels than its adult counterpart in the aftermath translate into lower productivity and human of the crisis, but its persistence poses the risk capital for these young workers later in life, of creating a “lost generation” of workers with substantially impairing the economy’s future weak job prospects and economic potential. potential growth. High youth unemployment Furthermore, it tends to differ structurally has also been shown to be associated with from adult unemployment, and thus policy increased income inequality (Morsy, 2012) as may need to be different. In SEE6 and EU11 well as higher incidence of unhappiness, mental countries, youth unemployment differs in health problems, and criminal offences (Bell other ways. The current young generation is the and Blanchflower, 2009). first to have been fully educated post-transition so they bring to the labor market a different Finally, in the context of rapidly aging mindset and skills than their parents. Failing populations across Europe, high youth to integrate this generation into the labor force unemployment also presents significant means countries could miss out on their most demographic and fiscal challenges in the productive generation to date. medium and long run. By 2030, the share of people aged 65 and over in the working age In addition, persistence of high youth population is projected to increase significantly unemployment poses risks to long-term in SEE countries. The old-age dependency economic growth and threatens to exacerbate ratio (the number of elderly compared with the inequality and social tensions. Empirical number of working age people) is set to increase research suggests that prolonged unemployment rapidly. On average, there were 1.8 people over early in one’s career can permanently reduce the age of 65 for every 10 people of working age in 2010 in SEE6 countries23. By 2030, Figure S1.3: Number of elderly per ten there will be 3 elderly people for every ten working age people people of working age. Some countries face particular difficulties (Figure S1.3). Bosnia 4.0 and Herzegovina and Serbia are projected to 3.5 have especially high old-age dependency ratios 3.0 with 3.6 elderly per ten of working age. SEE6 2.5 countries cannot therefore afford to exclude 2.0 young people from the labor market. This makes 1.5 the reduction in high youth unemployment a 1.0 pressing policy priority, both in terms of: (i) preventing a dramatic drop in the labor supply 0.5 and (ii) containing the fiscal cost of pensions 0 ALB BIH MKD MNE SRB SEE6 JJ 2010 JJ 2030 Source: World Bank staff based on UN Population data. 23 Excluding Kosovo. Based on United Nations Population data. 44  |  III. Spotlights BRITTLE RECOVERY and health care (long-term unemployment Positive growth rates matter more for imposes a considerable fiscal drain in terms of youth unemployment in SEE6 countries foregone future tax revenues). than in other European countries. In SEE6 countries, an additional percentage point of economic growth reduces youth Economic growth is necessary to reduce unemployment by 0.85 percentage points youth unemployment… compared to 0.29 percentage points for adult unemployment. In EU11 countries, an Youth unemployment tends to be more additional percentage point of economic growth sensitive to economic growth than adult reduces unemployment by 0.64 percentage employment. The relationship between the points among youth and 0.27 percentage yearly change in youth and adult unemployment points among adults. against GDP growth for all European countries in the period 1980–2012 confirms the Closing the large youth unemployment view that youth unemployment tends to be gaps existing between the SEE6 and EU17 “supercyclical” (see for instance Ryan 2001), countries will be a challenge. Closing half of responding more to both positive and negative the youth unemployment gap between EU17 economic shocks than does adult employment and SEE6 (based on the averages over the (Figure S1.4). In Europe, the within-country existing sample, 17.4 percent and 52.9 percent, standard deviation of youth unemployment respectively) in 15 years would require a rates is almost three times larger than that of yearly GDP growth differential of around adult unemployment rate (3.5 percentage 4.4 percentage points on average for SEE6 points versus 1.4 percentage points). countries with respect to EU17 economies. Growth differentials between SEE6 and other EU countries since 2000 has been significantly Figure S1.4: Yearly change in youth and lower than this (see the Medium-Term adult unemployment rate versus GDP growth Convergence Challenge section of this report). Change in unemployment rate, percentage points 15 10 …and skills, education and labor market policies matter 5 0 Around half of the variation in youth -5 unemployment in Europe in the period -10 2007–2012 can be explained by the -15 reduction in output with the rest attributed to differences in policies. The policies -20 -15 -10 -5 0 5 10 15 that appear to have helped to lower youth GDP growth, percent unemployment during the crisis include: (i) QQ Youth unemployment QQ Adult unemployment changes in the focus of education systems Sources: WDI and ILO. toward science, technology, engineering and III. Spotlights  |  45 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 mathematics; (ii) facilitating greater linkages between private sector firms and education institutions; and (iii) involving private firms in the development of vocational curricula. The results emphasize the important interaction between education institutions and the private sector in matching the skills of youth with the needs of the labor market. Countries can learn from each other’s experiences which types of labor market and education policies matter most for combatting youth unemployment. The SEE6 countries—where Enterprise Surveys reveal that, on average, 13 percent of firms identify an “inadequately educated workforce as major constraint to doing business”—could draw on the experiences from the rest of Europe to improve labor market outcomes. 46  |  III. Spotlights BRITTLE RECOVERY Spotlight 2. SEE6 Non-performing loans: Effects, Obstacles to Resolving and Reforms22 Banks in SEE6 countries have some of the households. High levels of NPLs undermine highest levels of non-performing loans economic growth by fueling excessive caution (NPLs) in the world. The average ratio of among lenders. In situations where a number NPLs to total loans in the region is 16 percent. of banks suffer from elevated levels of NPLs, A comparison of NPL levels in SEE6 with systemic concerns about the insolvency and some troubled and more stable economies is illiquidity of the banking system can arise. This provided in Figure S2.1 below. is a particular risk in small economies with concentrated banking systems. Figure S2.1: Banks’ Non-Performing Loans % of total loans Despite considerable efforts (see Table Greece S2.1) obstacles to reducing the high level Ireland of NPLs in the region are significant. Albania Serbia Obstacles include: (i) reluctance by banks to Slovenia Montenegro recognize “final status” losses on bad loans SEE6 Italy due to the adverse impact on their capital; Bosnia and Herzegovina (ii) many of the foreign parent banks need to FYR Macedonia Portugal strengthen their group-wide balance sheets Kosovo Spain and thus do not pressure the subsidiaries to Germany recognize losses and move on; (iii) regulatory United States 0 5 10 15 20 25 30 35 forbearance by some supervisory authorities Source: IMF and national authorities. has contributed to a poor approach to capital management; (iv) restructuring requires Dealing effectively with NPLs is important creditor cooperation, which is rarely practiced because their large volumes create a drag on in markets where lending competition has been overall economic growth. NPLs that are not strong in the years leading up to the crisis; cleared from the banking system tie up scarce (v) inadequate legal frameworks to underpin financial resources in unprofitable sectors. both voluntary NPL resolution actions (which When banks incur losses and need to provision should represent the bulk of the response) and for NPLs, their capital and capacity to lend enforced NPL resolution actions (in those cases to creditworthy clients is reduced. Delayed where borrower cooperation is absent). collection of NPLs strains banks’ liquidity leading to higher funding costs and, indirectly, The role of banking supervisors in creating to higher interest rates on new loans. This makes incentives for banks to reduce their NPLs borrowing less affordable for businesses and should also be emphasized and strengthened to avoid a prolonged period of subdued lending and consequent weak economic 24 This Spotlight is drawn from: World Bank. 2014. Fragile Stability, Western Balkans Financial Sector Outlook, No 3, (forthcoming). growth. Central banks are improving their III. Spotlights  |  47 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Table S2.1: Overview of Programs and Reforms under Way to Address NPLs in the Western Balkans Bosnia and FYR Type of Initiatives of Reforms Albania Kosovo Montenegro Serbia Herzegovina Macedonia Borrower mapping and recovery      plans Asset quality reviews in banks    Stronger supervision    Collective approach to debt   restructurings Reform of bankruptcy/judiciary  framework Reform of voluntary debt    restructuring framework Streamlining taxation issues   Streamlining civil code on    collateral enforcement Improving legal framework for    bulk sales of NPLs Main provider of technical World Bank IMF World Bank World Bank assistance Source: World Bank, IMF. Note:    Undertaken or in process;    Under discussion with IFIs crisis preparedness, but weaknesses remain in • Deficiencies in the collateral enforcement a number of areas, including macro-prudential process. Examples of common problems monitoring and policymaking, emergency include: (i) judicial foreclosure processes lending arrangements, information sharing that can be delayed by months or even amongst the financial safety net players, years due to difficulties in achieving deposit insurance, and bank resolution service process; (ii) non-judicial frameworks. Supervisors should require banks: foreclosures that are needlessly drawn out (i) to strictly conform to regulatory standards due to a requirement for multiple auctions on classification and provisioning; (ii) to (sometimes under non-transparent obtain realistic collateral valuations; (iii) to conditions) at prescribed discounts from obtain fresh capital from shareholders if they appraised value; (iii) delayed execution of are under-capitalized; and (iv) to provide the pledges on movable assets due to evasion proper incentives for banks to eliminate today’s tactics of borrowers. problem loans within a reasonable period. • Gaps in the legal framework for voluntary, out-of-court restructuring and tax Legal impediments to collecting and treatment that impedes NPL resolution. resolving NPLs in the Western Balkans Common problems include: (i) write- should be addressed. These legal impediments offs of bad debt are not treated as tax- include: deductible expenses for the lender; (ii) sale of (performing or non-performing) 48  |  III. Spotlights BRITTLE RECOVERY loans (sometimes to a special collections or factoring agency) is subject to VAT or transfer tax at the full value of the outstanding loan; (iii) creation of a taxable event by debt forgiveness or other restructuring techniques; (iv) inability to deduct losses in a debt-equity swap when there is a difference between the face value of the debt and the “equity” value of the shares received; and (v) inability to carry forward losses in the context of mergers and acquisitions. III. Spotlights  |  49 BRITTLE RECOVERY Annex I: Key Indicators Figure AI.1: Real GDP: Percent Change since Pre-Crisis Peak percent change, 2008–13 real GDP index (2002=100) Albania 170 Bosnia and Herzegovina 160 Kosovo 150 FYR Macedonia 140 Montenegro Serbia 130 SEE6 120 EU11 110 EU15 100 -5 0 5 10 15 20 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Note: 2013 shows World Bank staff estimates. Figure AI.2: Real GDP Growth Projections, 2014 projected GDP growth in 2014, percent percent Albania 12.5 Bosnia and Herzegovina 10.0 Kosovo 7.5 FYR Macedonia 5.0 Montenegro 2.5 Serbia 0 SEE6 -2.5 EU11 -5.0 EU15 -7.5 0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 2003 2005 2007 2009 2011 2013 2014 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff projections. Note: 2013 shows World Bank staff estimates and 2014 shows World Bank staff projections. Annex  |  53 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure AI.3: Unemployment Rate End of 2013, percent of labor force percent of labor force Albania 40 Bosnia and Herzegovina 35 Kosovo FYR Macedonia 30 Montenegro 25 Serbia 20 SEE5 (excl. KOS) EU11 15 EU15 10 0 5 10 15 20 25 30 35 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Notes: Kosovo as of 2012. Figure AI.4: Fiscal Balance Estimated fiscal deficit in 2013, percent of GDP percent of GDP Albania 7.5 Bosnia and Herzegovina 5.0 Kosovo 2.5 FYR Macedonia 0 Montenegro Serbia -2.5 SEE6 -5.5 EU11 -7.5 0 1 2 3 4 5 6 7 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Note: 2013 shows World Bank staff estimates. 54  | Annex BRITTLE RECOVERY Figure AI.5: Public Debt Estimated public debt and guarantees in 2013, percent of GDP percent of GDP Albania 80 70 Bosnia and Herzegovina 60 Kosovo 50 FYR Macedonia 40 Montenegro 30 Serbia 20 10 SEE6 0 0 10 20 30 40 50 60 70 80 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Note: 2013 shows World Bank staff estimates. Figure AI.6: Export Growth 2013, percent percent Albania 50 40 Bosnia and Herzegovina 30 Kosovo 20 10 FYR Macedonia 0 Montenegro -10 Serbia -20 -30 SEE6 -40 0 5 10 15 20 25 30 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Annex  |  55 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure AI.7: Import Growth 2013, percent percent Albania 60 50 Bosnia and Herzegovina 40 Kosovo 30 20 FYR Macedonia 10 Montenegro 0 Serbia -10 -20 SEE6 -30 -5.0 -2.5 0 2.5 5.0 7.5 10 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Figure AI.8: Current Account Balance Estimated current account balance in 2013, percent of GDP percent of GDP Albania 20 10 Bosnia and Herzegovina 0 Kosovo -10 FYR Macedonia -20 Montenegro -30 Serbia -40 -50 SEE6 -60 -20 -15 -10 -5 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Note: 2013 shows World Bank staff estimates. 56  | Annex BRITTLE RECOVERY Figure AI.9: Deposit and Private Credit Growth private credit growth, percent deposit growth, percent 160 100 140 80 120 60 100 80 40 60 20 40 0 20 -20 0 -20 -40 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: World Bank staff calculations. Figure AI.10: Non-Performing Loans 2013, percent of total loans percent of total loans 25 Albania Bosnia and Herzegovina 20 Kosovo 15 FYR Macedonia 10 Montenegro 5 Serbia 0 0 5 10 15 20 25 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: Central banks. Annex  |  57 SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.6 Figure AI.11: Ease of Doing Business 2013, proximity to frontier (best practice=100) proximity to frontier (best practice=100) Albania 80 Bosnia and Herzegovina 75 70 Kosovo 65 FYR Macedonia 60 Montenegro 55 Serbia 50 SEE6 45 EU11 40 40 45 50 55 60 65 70 75 80 2006 2007 2008 2009 2010 2011 2012 2013 2014 ▬▬ ALB ▬▬ BIH ▬▬ KOS ▬▬ MKD ▬▬ MNE ▬▬ SRB Source: Doing Business. 58  | Annex