South East Europe Regular Economic Report #5 (December 2013) by World Bank in Europe & Central Asia

Report No. 83136-ECA

South East Europe Regular Economic Report No.5 Slow Road to Recovery

December 9, 2013 â&#x20AC;&#x192;

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 is led by Gallina Andronova Vincelette, Željko Bogetić, and Abebe Adugna; the following team members have thematic and/or country assignments: Simon Davies (fiscal and debt; and Bosnia and Herzegovina); Agim Demukaj (external sector; and Kosovo); Doerte Doemeland, Nikola Kojucharov, and Ivan Kusen (labor market; monetary policy; inflation developments); Raquel Letelier (financial sector); Anil Onal (database management; and Albania); Lazar Sestović (real sector; and Serbia); Sanja Madzarević-Sujster (Montenegro); Bojan Shimbov (financial sector, FYR Macedonia), Ekaterine Vashakmadze and Mizuho Kida (global developments and outlook); Maria Andreina Clower, Christopher Pala, and Budy Wirasmo provided invaluable assistance in editing and designing this report. Dissemination of the report as well as external and media relations is managed by Lundrim Aliu, Anita Bozinovska, Ana Gjokutaj, Jasmina Hadzić, Andrew Kircher, Vesna Kostić, Sanja Tanic; Boris Balabanov, 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 East 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 202-5222422, e-mail pubrights@worldbank.org.

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Contents Summary 1 Chapter 1: Recent Macroeconomic Developments 5 Modest Growth after the Double-Dip Recession 5 Continued Improvements in Trade and External Debt 9 Nascent Employment Gains 11 Disinflation 13 Depressed Credit Growth 15 Persistent Fiscal Pressures 21 Chapter 2: Macroeconomic Outlook Weak Growth Ahead From Weak to Robust Growth: Improving Productivity and Competitiveness Improved Business Climate, but Further Reforms Needed

27 27 28 29

Annex: Macroeconomic Indicators

List of Figures Figure 1: Economic Growth Rates in SEE6 Figure 2: Growth of Industrial Output in 2013 Figure 3: Global Industrial Production and Trade: Recovering Figure 4: Borrowing Costs in Select European Countries: Moderating Figure 5: SEE Labor Productivity in SEE vs. EU11 and EU15 Figure 6: Labor Productivity in the SEE Figure 7: Real Unit Labor Costs Figure 8: Contributions to Change in Unit Labor Costs Since 2008 Figure 9: SEE6 Combined Current Account and Trade Balances Figure 10: SEE6 Countries’ Half Year Current Account Balance

iv | Contents

5 6 7 7 8 8 9 9 10 10

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Figure 11: SEE6 Export Growth Figure 12: Worker Remittances 2010–H1 2013 Figure 13: Average SEE6 External Debt Figure 14: Total Public and Private External Debt 2010–H1 2013 Figure 15: Employment in Regional Context Figure 16: SEE: Paths of Employment Recovery Figure 17: Sectoral Drivers of Employment Recoveries Figure 18: Unemployment Rates 2013 Figure 19: Unemployment Rates in Regional Context Figure 20: CPI inflation Figure 21: Food Price Inflation Figure 22: Energy Price Inflation in SEE6 Figure 23: Regional CPI Inflation Comparison Figure 24: Output Gaps in SEE6* Figure 25: Official Policy Rates Figure 26: Real Broad Money Supply Figure 27: Funding and Funding Costs for SEE6 Countries Figure 28: CDS Spreads of SEE countries Figure 29: Non-performing Loans Figure 30: Asset Quality of Loan Portfolio, December 2012 Figure 31: Loan-to-Deposit Ratios Figure 32: Capital Adequacy Ratio Figure 33: Liquidity Ratio Figure 34: Credit Growth Rates Figure 35: Average Structural Fiscal Balance and Economic Growth Figure 36: Structural Fiscal Balances Figure 37: Fiscal Deficits Figure 38: Contribution Toward Change in Deficits, 2012–13 Figure 39: Public Expenditure Figure 40: Contribution Toward Change in Spending, 2009–12 Figure 41: Wage Bill and Social Benefit Spending, 2012 Figure 42: Benefits Coverage of Households Figure 43: Benefits to Top and Bottom Quintiles Households Figure 44: General Government Debt without Guarantees Figure 45: State Guarantees Figure 46: Distance to Frontier on the Ease of Doing Business, 2009–13 Figure 47: SEE6 Distance to the Frontier in the Areas of Doing Business, 2009 vs. 2013

Contents

10 10 11 11 12 12 12 13 13 14 14 14 14 15 15 15 16 16 17 17 20 20 20 21 22 22 22 22 23 23 23 24 24 24 24 30 30

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

List of Tables Table 1: Growth of Goods Exports Table 2: Asset Shares of Foreign Banks in SEE6, 2012 Table 3: Economic Growth Rates 2012–14

6 16 27

List of Boxes Box 1: External Developments in 2013 Box 2: NPL Resolution Efforts in SEE6: The Experience to Date Box 3: Implications of Croatia’s EU Accession for SEE6

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7 18 29

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Summary Recent Economic Developments The South East Europe (SEE6) region exited from recession in the first half of 2013, supported by a nascent recovery in the Euro area. Industry––especially manufacturing exports and energy––drove the recovery. The region experienced a welcome surge in exports in 2013, particularly car exports from Serbia. Favorable weather conditions supported a strong contribution of agricultural output to economic growth and helped weaken inflationary pressures. However, domestic demand remained depressed in most of the region, reflecting high unemployment, sluggish growth of household incomes and credit, and a difficult investment climate. Only in Kosovo and FYR Macedonia did public investment contribute to some strengthening of domestic demand. Beyond these short-term factors, a slowdown in productivity growth and rising unit labor costs adversely affected economic growth, lowering competitiveness and demand for labor. Unemployment in the region, at about 24 percent on average1, began to decline in the first half of 2013 from its peak crisis levels. While employment grew in Albania, FYR Macedonia and Montenegro, it remained depressed in Serbia and Bosnia and Herzegovina. But even where employment has recovered meaningfully since 2010, the gains were not broad-based and mostly concentrated in services Near-term 1 All SEE6 region-wide average aggregates are simple averages unless specifically noted otherwise.

economic growth will be too weak to support substantial gains in employment. As export performance strengthened and imports declined, current account balances narrowed. The gradual recovery in the Euro Area helped the combined (weighted average) goods exports of SEE6 to grow by close to 13 percent (year-on-year), making a strong positive contribution to overall economic growth. Export growth picked up everywhere, propelled by new foreign direct investment (FDI)-based export capacity. However, the sustainability of this high export growth is uncertain in view of the region’s narrow export base and competitiveness issues. Weak domestic demand depressed imports in all countries but Serbia, where their rise was led by raw materials and parts used in export-oriented industries. FDI remained sluggish in SEE6, rising only by 0.7 percent of gross domestic product (GDP), but its share of financing of the current account increased. Remittances continued to be resilient overall, but the Greek crisis began to take its toll, especially on Albania. Foreign banks’ deleveraging from SEE6, rising non-performing loans (NPLs) and weak credit growth underpinned the need for vigorous reforms to reduce vulnerabilities in the financial sector. European banks continued to deleverage and reduced their exposure to the SEE6 region. With the aim of improving their resilience and supervisory capacity, the SEE6 countries made some progress in implementing banking reforms over the past year. Banks remained well-capitalized with actual capital-adequacy

Summary

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

ratios above the regulators’ requirements in all six countries. Liquidity was high at 25–35 percent of total assets. However, NPLs reached worrisome levels at above 20 percent of total loans in Albania and Serbia and about 18 percent in Montenegro. Their rise stemmed from the sluggish state of the economy, weak insolvency regimes and widespread payment indiscipline in the private sector, exacerbated by public sector arrears to businesses in some of the SEE6 countries. In this environment, despite ample liquidity and cuts in policy rates, banks remained reluctant to extend new loans. As a result, credit growth slowed in most SEE6 countries. Fiscal deficits remained high and public debt increased in 2013. The SEE6 average fiscal deficit is expected to remain at elevated levels at 4.2 percent of GDP in 2013 (compared to 4.1 percent of GDP in 2012). Structural rigidities in public expenditures, the weak tax base, and depressed fiscal revenues contributed to this outcome. Despite some fiscal consolidation efforts, the SEE6 governments did not address key rigidities such as the high public sector wage bill (averaging over Economic Growth Rates, 2012–2014 2012

2013f

2014f

1.6

1.3

2.1

-1.1

0.8

2.0

2.7

3.0

4.0

FYR Macedonia

-0.4

2.5

3.0

Montenegro

-2.5

1.8

2.5

Serbia

-1.7

2.0

1.0

SEE6*

-0.7

1.8

Memo item: Euro Area

-0.6

-0.4

1.1

Albania Bosnia and Herzegovina Kosovo

Source: World Bank staff projections. Note: Weighted average.

2 | Summary

9 percent of GDP) and the poorly targeted social transfers (at 12.5 percent of GDP on average). As a result, the pace of the fiscal adjustment remained insufficient to reverse the adverse debt dynamics in some countries. Average public debt increased in SEE6 and is expected to reach 45 percent of GDP by end2013, from 42 percent a year earlier. Public debt remained at above 60 percent of GDP in Albania, Montenegro, and Serbia.

Growth Outlook and Risks With depressed domestic demand, uncertain export prospects, and significant external risks, the SEE6 short-term outlook remains frail. After the bounce-back of the regional economy in the first half of 2013 and taking into account the latest high-frequency data, economic growth for the year is expected be around 1.8 percent. Net exports will continue to drive growth in SEE6 in the short term. However, given the limited export base of the SEE6 economies and the uncertain new FDI-driven export capacity, sustained export-led recovery is by no means assured. Much depends on a lasting recovery of external demand. In contrast, unfavorable labor market conditions, a poor investment climate, and difficult credit conditions that depress consumption and investment will keep a lid on the overall economic activity. Therefore, weighted real GDP of the SEE6 region is now expected to grow 1.8 percent in 2014, about one percentage point less than the earlier, mid-2013 estimate. The slowdown is driven by the Serbian economy, which is now expected to expand by only 1 percent in 2014 (compared to a 2 percent mid-2013 estimate) because of the planned fiscal consolidation and a declining private consumption. In contrast

SLOW ROAD TO RECOVERY

to Serbia, economic growth in the other five SEE countries is expected to firm up in 2014 and exceed the pace of economic expansion of 2013. Risks to the SEE6 near-term outlook are on the downside. Main external risks relate to the pace of the increase in global interest rates and sovereign borrowing costs arising from a possible tapering of quantitative easing in the U.S.; the Euro Area recovery; and deleveraging and the potential exit of parent banks from the SEE6 countries. Internal risks relate to “reform fatigue” that may delay policy implementation, and daunting fiscal and debt challenges in several countries. Also, slow resolution of NPLs, arrears accumulation in some countries, and depressed credit growth could further dampen prospects for growth.

now enjoy dynamic, open, and export-oriented economies with large FDI and associated transfer of technology and know-how. With the recent progress of European Union (EU) candidate countries Montenegro and Serbia, and the agreement between Serbia and Kosovo presaging greater stability and security, the perception of the regional investor risk may decline gradually over time. Croatia’s accession to the EU, the opening of the accession process of Serbia, and the progress made by Montenegro, as well as recent political changes in the region, may provide a renewed impetus for reforms. The time to use that opportunity is now.

Beyond this difficult short-term horizon, how can SEE6 raise their longer-term growth prospects? While maintaining macroeconomic stability remains a top policy priority, structural reforms will have to be pursued with vigor. The nascent export-led growth of 2013 is a positive development, but sustaining it will be a challenge. In addition to the need to improve their fiscal positions, reduce public debts, and strengthen banking systems, SEE6 face significant structural challenges in improving productivity and competitiveness, including in the areas of the investment climate, the labor market, and the public sector. Overcoming these challenges is possible. A similar structural transformation challenge has been successfully met by the Baltics, Poland, the Czech Republic, and Slovakia, among other countries. They began their transition two decades ago under unfavorable conditions and

Summary

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Chapter 1: Recent Macroeconomic Developments Modest Growth after the Double-Dip Recession On the heels of a tepid recovery of the Euro Area, the SEE6 region exited from recession in the first half of 2013. The combined real GDP of the SEE6 countries rebounded from a 0.7 percent decline in 2012 to a 1.8 percent growth (y-o-y) in the first half of 2013 (Figure 1). Economic growth was backed by a slowly recovering external demand for SEE6 exports (Box 1). While economic growth in Serbia and Albania (at 1.4 percent) was led by industry, agriculture, and exports, the Macedonian growth (at 3.4 percent, the highest in the region) reflected a strong recovery in construction and services in the first half of 2013.

Industry––especially manufacturing exports and energy––drove the recovery in 2013. In contrast to 2012, industrial output grew across the region in the first half of 2013 (Figure 2). In Serbia, the start of production and exports by FIAT exceeded expectations, with over 100,000 cars exported so far this year. In the other SEE6 countries, industrial output growth was weaker, but contributed positively to the overall economic recovery. Good weather conditions supported a strong contribution of agriculture to economic growth in SEE6. Because only a small share of

Figure 1: Economic Growth Rates in SEE6 percent, annual growth

percent, semi-annual y-o-y growth

-1

-2

-3

-3 ALB

BIH

KOS

MKD MNE

SRB

SEE6 EU15 EU11

JJ 2012

ALB JJ H1 2012

BIH

KOS

MKD MNE

SRB

SEE6 EU15 EU11

JJ H1 2013

Source: National statistics offices, and World Bank staff estimates. Note: no quarterly data available for Kosovo and Bosnia and Herzegovina; figures are projection for the year.

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 2: Growth of Industrial Output in 2013

Table 1: Growth of Goods Exports in Euro Terms

percent, q-o-q

H1 2012

20 18

Albania

Bosnia and Herzegovina

14 12

Kosovo

FYR Macedonia

H1 change 2013 in %

720

840

16.7

1,250

1,382

10.6

135

149

10.4

1,507

1,523

1.1

194

209

7.7

Montenegro

Serbia

4,145

4,993

20.5

SEE6

7,951

9,096

12.6

4 2

Source: National statistics offices and World Bank staff estimates.

0 ALB JJ Q1

BIH

MKD

MNE

SRB

JJ Q2

Source: National statistical offices.

arable land is irrigated and/or protected from floods, agricultural output critically depends on weather conditions. In Serbia, after 20 percent drop in the previous year, agriculture grew 21 percent in the first half of 2013 (y-o-y) with better weather, contributing 1.6 percentage points to the overall GDP growth. Elsewhere, growth was less strong but positive. For example, in FYR Macedonia, agriculture output grew 0.7 percent and anecdotal evidence from Kosovo also suggests a good agricultural year because of weather and donor-funded projects in the sector. Greater supply helped reverse the food price inflation from a year ago. On the demand side, exports drove the economic recovery in SEE6. The gradual recovery in the Euro Area helped the combined goods exports of SEE6 to grow by close to 13 percent (y-o-y), making a strong positive contribution to overall economic growth (Table 1). Serbia led this export surge with investments by large foreign companies (including FIAT, Michelin, and Stada): its exports grew by 20.5 percent in the first half of 2013 compared to the same period of 2012,

6 |

Chapter 1: Recent Macroeconomic Developments

with a 5.1 percentage point contribution to real GDP growth. Preliminary data suggest that this export surge continued in the third quarter of 2013 with an estimated growth of 38.5 percent (y-o-y). In addition to recovering external demand from the EU, SEE6 countries’ export growth was influenced by temporary factors. For example, Montenegro and Bosnia and Herzegovina benefited from a surge in electricity exports from its hydropower plants using record water accumulations. Also, an increase in food exports from Bosnia and Herzegovina to Croatia was related to that country’s entrance to the EU. Domestic demand remained mostly depressed in SEE6 in 2013. Although statistics on the expenditure side of the SEE6’s GDP are only available for FYR Macedonia and Serbia, several indicators—credit, wages, inflation, unemployment, imports, and household debt— all suggest depressed domestic demand. In Serbia, domestic consumption and investment had an especially negative contribution to GDP

SLOW ROAD TO RECOVERY

Box 1: External Developments in 2013 Following several years of weakness, growth in high-income countries is firming, including in the Euro Area (Figure 3). High-income countries’ growth accelerated in Q2 2013, led by the United States; the Euro Area recovered after 6 quarters of contraction, and robust growth came to Japan. This acceleration softened in the Euro Area and Japan in the third quarter. In the US, growth led by the private sector increased to 2.8 percent from the previous quarter, despite rising interest rates and the effects of fiscal sequestration. The Euro Area recession has ended with annualized growth in Q2 at 1.2 percent across a range of economies and PMI surveys suggested stronger consumer and import demand. However, Germany and France lost the momentum in Q3, recording 1.2 percent and negative 0.5 percent growth rates, respectively. Economic activity has strengthened in China in recent months (Q3 up to 9.3% from 7.3% in Q2) and is recovering in other large middle-income economies including South Africa, Turkey and Brazil, although Q2 outturns disappointed in India and Mexico.

Figure 3: Global Industrial Production and Trade: Recovering

Figure 4: Borrowing Costs in Select European Countries: Moderating

percent, 3m/3m saar

credit default swap rates, basis points

1,800

1,600

1,400

1,200

1,000

800

0 600 -5 400

-10

200

-15

▬▬ High income industrial production

▬▬ High income imports

▬▬ Developing country exports

Source: World Bank and the Datastream.

▬▬ Spain

▬▬ Ireland

▬▬ Italy

1-Oct-13

1-May-13

1-Dec-12

1-Jul-12

1-Feb-12

1-Sep-11

1-Apr-11

1-Nov-10

1-Jun-10

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

Jun-12

Mar-12

Dec-11

Sep-11

Jun-11

Mar-11

▬▬ Developing industrial production

1-Jan-10

-20

▬▬ Portugal

Source: World Bank and the Datastream.

Capital flows to developing countries began to rebound and pressures on asset prices and currencies eased. However, there remain risks and uncertainty related to the eventual timing of tapering and its impacts on developing countries. Global capital flows remain volatile: gross capital flows to developing countries dropped in October, fully reversing the earlier rebound in September. Markets seem to be discriminating on the basis of domestic policy frameworks and risks. The transition to higher interest rates poses risks of a disorderly adjustment if rates rise too rapidly or a sudden stop in capital flows exposes country-level vulnerabilities. Although some adjustment has taken place (the average long- term cost of bond financing for developing countries tightened by 50 basis points since May), U.S. yields likely have a further 200–220 basis points to rise, with developing country yields likely to rise by an average 300–350 basis points in the medium-term. Economies with substantial vulnerabilities could see their cost of borrowing rise much more. The temporary decision by the Fed to maintain quantitative easing at current pace has delayed the impact on developing countries facing external financing vulnerabilities.

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

growth of about 2 percentage points each in the first half of 2013. Only in FYR Macedonia and Kosovo did domestic demand strengthen, mainly because of increased investments. In FYR Macedonia, for example, investment increased by 8.2 percent in the first half of 2013 (y-o-y), driven by investment in large public sector projects.

productivity growth dipped to a level below the one in 2008 in several countries, as sluggish output growth failed to keep pace with the upturn in employment (Figure 6).

Figure 5: SEE Labor Productivity in SEE vs. EU11 and EU15

Figure 6: Labor Productivity in the SEE

index (2008=100)

110

Sluggish productivity growth and rising unit labor costs in several countries affected negatively economic growth. Only in Albania

120

105

110

100 95

100

85 80

70 60

65 60

50 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

▬▬ SEE5 (ex Kosovo)

▬▬ EU-11

▬▬ EU-15

2004

2005

2006

2007

2008

2009

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ Montenegro

▬▬ Serbia

2010

2011

2012

▬▬ FYR Macedonia

Source: National statistics offices, World Bank staff estimates.

Against these short-term developments, productivity growth—a key driver of longrun growth—slowed substantially in the past two years. In the years prior to the global financial crisis, labor productivity grew faster in the SEE6 countries than EU11 and EU15, a pattern that was sustained in the immediate aftermath of the crisis (Figure 5).2 Since the beginning of 2012, however, SEE labor

and Serbia did real unit labor costs decline after 2008 (Figure 7), aided in part by the stronger productivity growth in these two economies compared to the rest of the SEE. But real wages in Bosnia and Herzegovina and FYR Macedonia, for example, continued to grow, while productivity growth fell (Figure 8). This led to further increases in unit labor costs in these countries despite the persistent slack in their labor markets. The labor demand and trade competitiveness channels adversely affected economic growth.

2 EU11 comprises Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, and Slovenia. The group of EU15 countries comprises: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom.

8 |

Chapter 1: Recent Macroeconomic Developments

SLOW ROAD TO RECOVERY

Figure 7: Real Unit Labor Costs

Figure 8: Contributions to Change in Unit Labor Costs Since 2008

index (2008=100)

percentage points

120

110

100

-5

-10

-15

-20 2004

2005

2006

2007

2008

2009

2010

2011

▬▬ Albania

▬▬ Bosnia & Herzegovina ▬▬ FYR Macedonia

▬▬ Montenegro

▬▬ Serbia

2012

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.

Note: 2009 reflects a structural break in the data for FYR Macedonia due to methodological revisions in the definition of gross wages, which excluded food and transport allowances in the period 2004–2009.

Continued Improvements in Trade and External Debt Current account balances narrowed in all SEE6 countries on the back of recovering European Union (EU) demand for exports. Both increases in exports and declines in imports contributed to a major rebalancing in trade and improvements in current account balances (Figure 9, Figure 10 and Figure 11). While intraregional SEE6 trade grew in 2012, exports began to shift towards the EU in 2013. That was true especially for Bosnia and Herzegovina, FYR Macedonia, and Serbia; while Montenegro’s and Kosovo’s share of exports to the SEE region increased. Current account deficits (CAD) were primarily financed by portfolio investments and FDI. Portfolio investments were the largest source of financing in the first half of 2013, accounting for almost half of CAD’s

financing. The FDI share of CAD financing grew strongly from 18.4 percent in 2012 to about 45.3 percent in the first half 2013. FDI financed one third of the CAD in Serbia and Montenegro, about a half of FYR Macedonia’s, two-thirds of Bosnia and Herzegovina’s, and over 90 percent of Kosovo’s and Albania’s. Average FDI flows to the SEE6 countries increased in 2013, albeit from low levels. FDI in Serbia and FYR Macedonia—mostly in manufacturing—doubled, although from a very low base. In Kosovo and Albania, the FDI were directed mostly towards infrastructure— the Prishtina Airport and hydro-power plants, respectively. While remittances to SEE6 decreased in 2013, they remained broadly resilient to the

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 9: SEE6 Combined Current Account and Trade Balances

Figure 10: SEE6 Countries’ Half Year Current Account Balance

percent of GDP

percent of GDP 0

-5 -5

-7.0

-10

-9.9

-15

-10

-11.9

-20 -14.9

-15

-25 -30

-20

-22.0

-22.8

-35

-25

-40 2011

JJ CAD

2012

H1 2013

MNE

JJ Trade balance

JJ H1 2011

Source: Central banks, IMF WEO, and World Bank staff calculations.

KOS

SEE6

JJ H1 2012

ALB

SRB

MKD

BIH

JJ H1 2013

Source: SEE6 Central Banks. Note: Montenegro’s current account deficit narrows usually in Q3 due to the main tourist season, producing a lower annual external deficit.

Figure 11: SEE6 Export Growth

Figure 12: Worker Remittances 2010–H1 2013

percent

percent of GDP

-5

-10

0 ALB

JJ 2011

BIH JJ 2012

KOS

MKD

MNE

SRB

KOS

SEE6

JJ H1 2013

Source: Central banks, IMF WEO, and World Bank staff calculations.

JJ 2011

BIH

SEE6

JJ 2012

ALB

MNE

SRB

MKD

JJ H1 2013

Source: SEE6 central banks. Note: Albania, Kosovo, and Bosnia and Herzegovina define remittances as including compensation of employees; Serbia and Montenegro use narrower definitions. Data for FYR Macedonia include only workers remittances coming through official bank channels and reported as such, but not all private transfers.

Eurozone crisis. Remittances to the region declined by 0.5 percentage point as a share of GDP in the first half 2013 (Figure 12) mainly because of the economic conditions migrants faced in Italy and Greece. The largest drop was in Albania, where the size of the contraction

10 |

Chapter 1: Recent Macroeconomic Developments

was more than 2 percentage points of GDP, as a result of many migrants returning from Greece. External debt remained high, albeit receding, mainly due to private sector deleveraging (see fiscal section). Total external debt in

SLOW ROAD TO RECOVERY

Figure 13: Average SEE6 External Debt

Figure 14: Total Public and Private External Debt 2010–H1 2013

percent of GDP

120

70 69.5

65.8

67.1

40 30 20

100

63.3

30.5 24.4

30.6

26.4

0 2010 JJ External debt

2011

2012

MNE

H1 2013

JJ o/w Gov. debt

Source: SEE6 central banks and ministries of finance (MoF).

JJ 2010

SRB JJ 2011

SEE6

MKD JJ 2012

BIH

ALB

KOS

JJ H1 2013

Source: SEE6 central banks and ministries of finance; IMF; World Bank. Note: Montenegro’s and Kosovo’s external debt are estimates. Kosovo external debt also excludes potential debt to the London Club and the Paris Club.

SEE6 declined by 2.4 percentage points to 67.1 percent of GDP in the first half 2013, mainly because of the large 5.2 percentage point decline of Serbia’s external debt (Figure 13, Figure 14). In addition to Serbia, external debt declined in FYR Macedonia by 0.9 percent of GDP, and in Kosovo3 and Albania by about 0.3 percent of GDP, respectively (Figure 14).

3 External private debt for Kosovo is an estimate and might be slightly underestimated.

Nascent Employment Gains

While employment rates in SEE6 improved in 2013, their increase made only a small dent in the high unemployment rates. Compared to the EU11 and EU15, where employment levels remained noticeably below their pre-crisis peaks, the SEE6 employment was nearly back to its 2008 pre-crisis peak level in the first half of 2013 (Figure 19). However, gains in employment are slow to translate into substantial decline in unemployment rates. Albania, FYR Macedonia and Montenegro experienced the strongest job growth since 2010, while employment in Serbia and Bosnia and Herzegovina remains depressed (Figure 16). Even where employment has recovered meaningfully since 2010, the gains have not been broad-based, but concentrated mostly on service sectors. In contrast, industry continued to lose jobs (Figure 17).

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 15: Employment in Regional Context

Figure 16: SEE: Paths of Employment Recovery

index (2008=100)

105

110

105 100 100 95 95 90 90

85 2007

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 ▬▬ SEE5 (ex Kosovo)

▬▬ EU-11

▬▬ EU-15

2008

2009

2010

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ Montenegro

▬▬ Serbia

2011

2012

▬▬ FYR Macedonia

Source: Eurostat, National statistics offices.

Source: National statistics offices.

Unemployment in the SEE6 has remained stubbornly high, despite slight recent declines in some countries. The average unemployment rate for the SEE6 was 23.6 percent as of mid2013, well above the EU-11 average, and showing little improvement from peak crisis levels (Figure 18). Only in FYR Macedonia did unemployment decline substantially, albeit from very high levels. Albania’s unemployment rate (12.8 percent) remained the lowest among the SEE6, while Kosovo’s, at 30.9 percent, remained the highest.4 By contrast, in EU11 and EU15, unemployment rates have continued to rise (Figure 19).

Figure 17: Sectoral Drivers of Employment Recoveries

4 Kosovo recently released the 2012 unemployment figure from its Labor Force Survey after a 3-year gap in the data.

12 |

Chapter 1: Recent Macroeconomic Developments

percentage points 10 8 6 4 2 0 -2 -4 Albania JJ Agriculture

JJ Industry

FYR Macedonia JJ Services

Source: Eurostat, National statistics offices.

Montenegro QQ Total

SLOW ROAD TO RECOVERY

Figure 18: Unemployment Rates 2013

Figure 19: Unemployment Rates in Regional Context

percent of labor force

30 33.5

27.6 25.5 27.5

25 20.5

30.9 28.8

23.5

20 15 10

13.8

19.2

10 12.8

5 0

0 ALB

QQ Crisis time

MNE

SRB

▬▬ SEE6 average

BIH

MKD

KOS

▬▬ EU11 average

Source: National Labor Force Surveys.

2007 ▬▬ SEE5

2008 ▬▬ EU-11

2009

2010

2011

2012

H1 2013

▬▬ EU-15

Source: Eurostat, National LFS data, World Bank staff estimates.

Note: Q2 2013 data for all except Kosovo (2012). Kosovo changed its LFS methodology in 2012, making previous year’s figures incomparable.

Disinflation Inflation in SEE6 decelerated in the first three quarters of 2013 on the back of stabilizing energy and food prices. The drop in CPI inflation—relative to peak rates in December 2012/January 2013—was substantial: it ranged from 7.9 percentage points in Serbia to 3.5 percentage points in Kosovo, and 3 percentage points in FYR Macedonia (Figure 20). Most of the slowdown reflects the dissipation of one-off factors that pushed up inflation in 2012––administered prices, some tax hikes, and the impact of bad weather on agricultural output and the food supply. Food inflation dropped by 9 percentage points (Figure 21), while energy inflation fell 5 percentage points. Serbia was an exception where inflation temporarily spiked in August owing to a one-time increase in retail electricity prices (Figure 22). With these developments,

as of September, CPI inflation in SEE6 (2.5 percent) converged substantially, only one percentage higher than that of its regional peers (Figure 23). With subsiding inflation and still-high spare capacity, some SEE6 central banks eased monetary policy. Specifically, still-large output gaps in SEE6 (Figure 24) supported some loosening in the countries with flexible exchange rates (Albania and Serbia) and managed pegs (FYR Macedonia). Policy rates were cut by an average of 50 basis points in the first half of 2013 (Figure 25). To support liquidity, “euroized” countries (Bosnia and

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 20: CPI inflation

Figure 21: Food Price Inflation

percent (y-o-y)

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia ▬▬ Montenegro

▬▬ Serbia

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

Jun-12

Mar-12

Dec-11

-2

▬▬ Kosovo

▬▬ Albania

▬▬ SEE6

▬▬ FYR Macedonia ▬▬ Montenegro

▬▬ Bosnia and Herzegovina

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

Jun-12

Mar-12

Dec-11

20 18 16 14 12 10 8 6 4 2 0 -2 -4

▬▬ Kosovo

▬▬ Serbia

▬▬ SEE6

Source: National statistical offices and World Bank staff calculations.

Figure 22: Energy Price Inflation in SEE6

Figure 23: Regional CPI Inflation Comparison

percent (y-o-y)

18 16 14 12 10 8 6 4 2 0 -2 -4 -6

8 7 6 5 4 3 2 1

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia ▬▬ Montenegro

▬▬ Serbia

▬▬ Kosovo

JJ SEE6

JJ EU15

Sep-13

Aug-13

Jul-13

Jun-13

May-13

Apr-13

Mar-13

Feb-13

Jan-13

Dec-12

Sep-13

Jun-13

Mar-13

Dec-12

Sep-12

Jun-12

Mar-12

Dec-11

JJ EU11

▬▬ SEE6

Source: National statistical offices and World Bank staff calculations.

Herzegovina, Kosovo, and Montenegro)5 maintained relatively low rates of required reserves: 9.5 percent in Montenegro, 10 percent in Bosnia, and 10 percent in Kosovo.

Despite these efforts, SEE6 experienced limited recovery of monetary aggregates, mirroring sluggish real activity. The real broad money supply (M2) in Albania, FYR Macedonia, Montenegro, and Serbia has not increased appreciably since mid-2010. Only in Bosnia and Herzegovina and Kosovo has there been a measurable rise in real M2 since the crisis, but the scope for further expansion

5 Kosovo and Montenegro have unilaterally adopted the euro as their sole legal tender, while Bosnia and Herzegovina runs a eurobased currency board.

14 |

Chapter 1: Recent Macroeconomic Developments

SLOW ROAD TO RECOVERY

Figure 24: Output Gaps in SEE6*

Figure 25: Official Policy Rates

percent of potential GDP

percent

18 16

6 14 4

8 6

-2 4 -4

-6 2007

2008

▬▬ Montenegro

2009

▬▬ Serbia

2010

2011

2012

2013

▬▬ FYR Macedonia ▬▬ Albania

0 2008 ▬▬ Albania

2009

2010

2011

2012

2013

▬▬ FYR Macedonia ▬▬ Serbia

▬▬ Bosnia and Herzegovina

▬▬ Euro area (ECB refi rate)

Source: IMF WEO and Staff country reports.

Source: ECB, National statistical offices.

Note: *Estimates for Kosovo are not available.

Figure 26: Real Broad Money Supply index (2009:Q1=100)

Depressed Credit Growth

125 120 115 110 105 100 95

▬▬ SEE6

▬▬ EU15

Sep-13

Mar-13

Sep-12

Mar-12

Sep-11

Mar-11

Sep-10

Mar-10

Sep-09

Mar-09

▬▬ EU11

Source: IMF IFS, National central banks. Note: 2013:H1 data is expressed as an annualized rate.

is constrained by the limited external inflows within these countries’ exchange arrangements. On balance, however, the post-crisis monetary recovery in SEE6 has been broadly on par with regional peers, albeit considerably more volatile (Figure 26).

Funding conditions for SEE6 countries improved somewhat in 2013. After supportive measures taken by major world central banks, market sentiment improved and risk aversion declined.6 Credit Default Swaps (CDS) spreads reached their lowest levels in most SEE6 countries since early 2011 and equity markets rose (Figure 27, Figure 28). Gross capital inflows to SEE6 region rose in 2013, amounting to 0.5 percent of GDP. FDI saw a boost of 0.7 percent of GDP in the first half of 2013 and portfolio investments remained robust as capital markets remained supportive of SEE6 sovereign bond issuances.

6 A Bank for International Settlements (BIS) study “The euro area crisis and cross-border bank lending to emerging market” (http:// www.bis.org/publ/qtrpdf/r_qt1212f.htm) confirms that between mid-2011 and mid-2012 it was primarily parent bank stress that drove deleveraging.

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 27: Funding and Funding Costs for SEE6 Countries

Figure 28: CDS Spreads of SEE countries

in million of US$

basis points

3,000

1,000

1,400 1,200

2,000

800 1,000

1,000 600

800

400

600

0 -1,000 400 200

-2,000

200

JJ Change in BIS reporting banks external position vis-à-vis SEE6, lhs*

▬▬ Albania

▬▬ FYR Macedonia ▬▬ Montenegro

Oct-13

Q3-13

Q1-13

Q2-13

Q3-12

Q4-12

Q2-12

Q1-12

Q4-11

Q2-11

Q3-11

Q1-11

Q2-13

Q1-13

Q3-12

Q4-12

Q2-12

Q1-12

Q4-11

Q3-11

Q1-11

Q2-11

-3,000

▬▬ Serbia

▬▬ Parent banks CDS spread average, rhs** ▬▬ SEE6 sovereign CDS spread, bps, rhs*** Source: Bloomberg, Bank for International Settlements (BIS) and World Bank staff calculations. Note: *Countries included: 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.

Source: Bloomberg.

Table 2: Asset Shares of Foreign Banks in SEE6, 2012 percent of country’s total assets

Austria Greece Slovenia

However, European foreign banks continued to deleverage from the SEE6 region. European foreign banks, which dominate the SEE6 financial landscape (Table 2) remained under market and regulatory pressures that prevented them from expanding their balance sheets and encouraged their subsidiaries to keep diversifying their sources of funding. In fact, compared to the end of the third quarter of 2012, the international exposure by foreign banks dropped in SEE6 financial sector as parent banks continued to reduce their presence in the region. Austria’s Hypo Alpe Adria Bank, for example, put its subsidiaries in the region (Bosnia and Herzegovina, Montenegro and Serbia) for sale. Slovenia’s Nova Ljubljanska Banka (NLB) recently reached a restructuring plan with the European Commission to downsize portfolio, raising the risk of divestment from the region. While negotiations between

16 |

Chapter 1: Recent Macroeconomic Developments

Albania

28.8

Bosnia and Herzegovina

37.2

8.5

Kosovo

24.1

16.1

Macedonia

4.7

Montenegro

21.2

Serbia

16.4

18.8

23.0

16.9 17.0

14.0

3.5

Source: Bankscope, Central Banks.

the European Commission’s Directorate General for Competition and the National Bank of Greece (NBG) for restructuring of the bank are not yet concluded, one of the reported options would be for the NBG to withdraw from Southeastern. Against this backdrop, SEE6 countries made some progress in implementing banking reforms over the past year with the aim to improve their resilience and supervisory capacity, but challenges remained. Macro-

SLOW ROAD TO RECOVERY

Figure 29: Non-performing Loans

Figure 30: Asset Quality of Loan Portfolio, December 2012

percent of total loans

0 ALB

JJ Dec-12

BIH JJ Jun-13

KOS

MKD

MNE

SRB

QQ Peak since 2008

ALB

BIH

JJ Impaired (Category 2)

KOS

MKD JJ Substandard

SS Pre crisis level (end 2007)

JJ Loss

Source: National authorities and World Bank staff calculations.

Source: Central Banks of the SEE6 countries.

MNE

SRB

JJ Doubtful

Note: Data for pre-crisis NPL level (2006–2008) for Serbia refers to end of 2008 level only.

prudential frameworks were strengthened to varying degrees, home-host relations improved, and several countries made efforts to reduce their elevated NPLs levels (including with foreign technical assistance (see Box 2). However, there remain four challenges: (i) taming the still rising NPLs problem, (ii) bringing the high loan-to-deposit ratios down, in some countries (iii) increasing bank profitability, and (iv) resuming credit growth. NPLs continued to rise in the first half of 2013, reaching peak levels in most of the region. NPLs started rising in mid-2012 and continued to increase in each of the SEE6 countries in the first half of 2013 (Figure 29). Their rise in SEE6 reflected a mix of weak economic fundamentals, worsening loan quality (Figure 30) and weak insolvency regimes. In addition, weak fiscal discipline resulted in public sector arrears, which constrained private sector liquidity and decreased the ability of

companies to service their loans. NPLs reached worryingly high levels of above 20 percent of total loans in Albania and Serbia, and about 18 percent in Montenegro. In addition, impaired loans (Category 2 loans), which accounted for the bulk of the newly-created NPLs, remained still high in some countries and need close monitoring (Box 2). Loan-to-deposit ratios continued to be high in three of the six countries in the region ( Figure 31). Serbia has reduced its loan-to-deposit ratio and its banks increased their liquidity considerably, but it still has the highest ratio in the region, at 140 percent in mid-2013. Montenegro has the second highest level at 122 percent in mid-2013 (down from 167 percent in mid-2009), similar to Bosnia and Herzegovina. Bank profitability remained under pressure. Banks’ profitability, measured through the average return on assets (ROA) fell in the first half of 2013 in Albania, Bosnia and

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Box 2: NPL Resolution Efforts in SEE6: The Experience to Date ll six South East Europe countries have now received or begun discussions on external assistance to A support the resolution of NPLs. Carrying out NPL resolution processes requires significant efforts in a number of key dimensions, inter alia, including: (i) developing a clear, objective grasp of financial and regulatory incentives at play, both locally and internationally, legal and regulatory impediments, and shortfalls in organizational and technical abilities in the banks; (ii) introduction of voluntary debt restructuring frameworks, and a judiciary prepared to execute resolution of those uncooperative borrowers; (iii) a willingness to set achievable interim and longer-term NPL reduction goals and supervisory resolve to have them enforced; and (iv) introduction of voluntary debt restructuring frameworks, and a judiciary prepared to execute resolution of those uncooperative borrowers; and (v) engagement of a number of key local stakeholders to adopt the needed measures. All these dimensions have to be carefully sequenced in accord with an agreed, time-bound strategy. With the above set preconditions in place, the NPL reduction process is likely to require at least 18 months to demonstrate durable results. Albania: The Bank of Albania (BoA) with the Government has initiated a wide range of reforms in recent years to support the resolution of NPLs, covering legislative, procedural and taxation issues. In a bid to draw from international best practice to support the mitigation of NPLs, the BoA entered into an MOU with the World Bank Vienna Financial Sector Advisory Center (FinSAC) in October 2012. Recent 2013 amendments to the Civil Procedure Code adopted with FinSAC support aim to shorten and simplify collateral enforcement procedures and significantly reduce the court’s right to intervene in enforcement or foreclosure on real property. However, banks continue to face important tax ambiguities in their efforts to write off unrecoverable NPLs. To bring clarity to these matters, the Ministry of Finance on behalf of the Tax Authority launched in November 2013 a Working Group with the BoA, supported by legal and accounting experts from the respective institutions. As banks are continuing to keep a significant portion of unrecoverable problem loans in their balance sheets, if these tax ambiguities were resolved, banks’ could lower NPL levels by 5–6 percentage points. In October 2013, Bank of Albania has launched an NPL Resolution Platform involving enhanced supervisory intrusiveness with regard to NPL recovery and resolution strategies by banks, supported by FinSAC. The outcome of this initiative will be to strengthen the ability of the Central Bank to direct banks to step up their efforts to reduce the NPL stock in a compressed time-frame. Bosnia and Herzegovina: In response to the authorities request for technical assistance for an NPL resolution framework, in April 2013 the IMF conducted a diagnostic study to define various short- and long-term measures to help clean up the NPLs. The report is slated to identify steps to strengthen the framework for NPL resolution by removing tax and institutional obstacles. The IMF is considering providing follow-up technical assistance in two key areas: i) launching an “Istanbul Approach” to bad debt resolution, whereby debt of distressed companies with multiple creditors would be restructured collectively by a committee of creditors, and ii) developing a law on factoring and/or proposing new legislation on asset management companies to facilitate banks’ sale of problem assets. Additionally, the IMF diagnostic team findings point to a critical need to improve tax laws related to loan restructuring and loan sales, out–of- court corporate debt restructuring, the corporate insolvency law, and to the introduction of a comprehensive consumer bankruptcy regime. Taking advantage of the forthcoming asset quality review of selected banks requested by the IMF, FinSAC has proposed to add an NPL recovery mapping module that would create more transparency and stronger accountability for the banks’ efforts to de-risk their balance sheet.

18 |

Chapter 1: Recent Macroeconomic Developments

SLOW ROAD TO RECOVERY

Kosovo: Institutionally, there is no functional system for the collective resolution of NPLs and enterprise distress. The modern liquidation and re-organization statute, while broadly consistent with good practice, lies entirely dormant due to the lack of a framework for the training, licensing, supervision, or accountability of insolvency professionals. There is only one specialized commercial court, which is understaffed and under-resourced. Only recently did Kosovo introduce notary services and mediation services as alternative dispute resolution mechanisms, working under the Kosovo Chamber of Commerce and American Chamber of Commerce. Montenegro: The Central Bank of Montenegro (CBCG) has taken the lead in introducing the “Podgorica Approach,” a new integrated program to enhance NPL reduction. With technical assistance provided by the World Bank’s Vienna-based Financial Sector Advisory Center (FinSAC), the CBCG is in the process of implementing a more formal framework to enhance NPL reduction activities. Based loosely on the London Rules, the approach is designed to create an incentive-based, voluntary framework to support real restructuring (operational as well as financial) and to provide solutions for debt restructuring on a systematic scale. The approach is grounded in the proposed Lex specialis Law on Voluntary Financial Restructuring of Debts, which is expected to be enacted in late 2013. As part of the analytical underpinnings to establish the costs and benefits of financial restructuring, FinSAC has recently completed an extensive assessment of the recoverability of the four largest NPL bank portfolios, involving bottom-up analysis of 120 large non performing borrowers. The outcome was a demonstration of the critical importance of a successful financial restructuring initiative, as only a small portion of the NPL portfolio is expected to cure without strong remedial action. FYR Macedonia: Following a World Bank Technical Assistance project on contingency planning in mid-2012, the National Bank of Republic of Macedonia has developed an action plan aimed at enhancing crisis preparedness. The project focused on the tools, resources, powers and interagency coordination mechanisms available to the authorities in the event of a systemic crisis. The main goal of the proposed crisis contingency plan is to prevent and reduce the impact of a crisis by taking actions to: (i) better understand the risks (including NPL-related risks) and inter-connections in the financial system, (ii) use supervision to strengthen resilience of banks, (iii) establish relevant legislation and policies (including for NPLs), and (iv) have a strategy to manage a crisis using carefully selected scenarios.. FinSAC is contributing to building capacity at the NBRM, focusing on system-wide NPL reduction. Serbia: Although fully provisioned (based on local prudential and accounting standards), the high level of NPLs is a source of serious concern in Serbia. Through amendments to the decision on the Classification of Bank Balance Sheet Assets and Off-balance Sheet Items that were passed in December 2012, a more lenient regulatory treatment of overdue loans fully guaranteed with mortgages was introduced. Regulatory impediments have been eased for the sale of distressed assets to their corporate clients. Out-of-court restructuring of NPLs has been introduced, but banks’ response has been quite tepid, with only few recorded voluntary restructurings to date. There are issues with capacity of the designated mediator (Chamber of Commerce) and lack of awareness about the system by companies. The National Bank of Serbia drafted a set of amendments on the Decision on the Classification of Bank Balance Sheet Assets and Off-balance Sheet Items in order to remove some of the obstacles for dealing with NPLs. The amendments were put for public debate on November 27, 2013.

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 31: Loan-to-Deposit Ratios 180 160 140 120 100 80 60 40 20 0 ALB JJ Dec-12

BIH

KOS

JJ Jun-13

MKD

MNE

SRB

QQ Peak level since 2006

Source: National authorities and World Bank staff calculations. Note: Due to the accounting harmonization with the IFRS, data for Montenegro is not comparable to the last Report.

Herzegovina and FYR Macedonia, and only increased slightly in Serbia and Kosovo. In Montenegro, as positive credit growth resumed, bank profitability, too, turned positive for the first time since mid-2008. However, increased provisioning for the rising NPLs, additional regulatory compliance, and lower revenues continued to put pressure on profitability and the banks’ willingness to lend.

Figure 32: Capital Adequacy Ratio

Despite ample liquidity and notable cuts in policy rates throughout 2013, real credit growth remained elusive in the SEE6 region, failing to support economic recovery. Banks in SEE6 countries were well-capitalized (Figure 32). Liquidity in the banking system was also high at 25–35 percent of total assets (Figure 33). High liquidity and capital adequacy served as buffers against volatile financial flows and uncertainty about the funding and potential exit of parent banks. However, rapidly increasing NPLs, the introduction of tighter credit underwriting standards, and banks’ efforts to clean their balance sheets and contain costs added pressure on lending in 2013. This discouraged banks from resuming credit, especially to SMEs. As a result, overall credit growth in 2013 further weakened in the SEE6 region, except in Montenegro (Figure 34). Against this backdrop, what is the remaining priority reform agenda in the financial sector? First, the successful and sustainable reduction of NPLs is the most important task ahead. As noted above, since the last edition Figure 33: Liquidity Ratio 45

40 20

35 30

25 20

15 10

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ Montenegro

▬▬ Serbia

Q1-13

Q3-12

Q1-12

SRB

Q3-11

MNE

Q1-11

MKD

QQ Average (2006–08), quarterly

Q3-10

KOS

Q1-10

BIH JJ Jun-13

Q3-09

ALB JJ Dec-12

Q1-09

0 0

▬▬ FYR Macedonia

Source: National authorities and World Bank staff calculations.

Note: Data for Serbia for -Average 2006-2008 quarterly, refers to 2008 only.

20 |

Chapter 1: Recent Macroeconomic Developments

SLOW ROAD TO RECOVERY

Figure 34: Credit Growth Rates

evolution of foreign currency exposure to unhedged borrowers and take measures to limit or reduce lending in foreign currency or lending indexed to foreign currencies.

percent change 60 50 40 30 20

Persistent Fiscal Pressures

10 0 -10 ALB JJ 2009 JJ Q2 2013

BIH JJ 2010

KOS

MKD JJ 2011

MNE

SRB

JJ 2012

QQ Average growth 2003–05

Source: National authorities and World Bank staff calculations. Note: Average growth rate for the period 2003-2005 for Albania and Serbia, and for the period 2004–2005 for FYR Macedonia and Montenegro.

of the Report (June 2013), NPL levels had risen considerably and credit growth remained subdued. This highlights the need for decisive and comprehensive measures to bring down NPL levels. Second, further strengthening of the macro-prudential framework is needed. Even though considerable work has been done, additional effort is needed in reinforcing the capacities of the regulatory authorities (both human and financial) to implement recommendations of assessments already made. Third, foreign currency lending poses risks not fully recognized in the affected countries. Weak economic fundamentals and high level of foreign currency and foreign currency-indexed lending (ranging from 79 percent in Serbia to 49 percent in FYR Macedonia7) pose a potential risk in countries with domestic currencies. These countries should monitor closely the

7 FYR Macedonia managed to decrease foreign currency lending from 56 percent of all loans at end 2009 to the current level of 49 percent, while at the same time increased the amount of deposits in local currency from 41 percent of all deposits at end 2009 to 56 at end September 2013.

SEE6 fiscal deficits remained high, in part because of structural rigidities in public expenditures, weak tax bases, and depressed fiscal revenues. Fiscal balances were not restored in 2013, and deficits remained close to their peak levels in 2009. Despite some efforts to control expenditure in 2013, governments did not address the key structural rigidities underlying high public expenditures, namely, the high spending on wages and on poorlytargeted social transfers (Figure 35, Figure 36). In addition, the large informal economy and the weak regional economic recovery resulted in revenue losses in some of the countries (Albania, Montenegro, Serbia,) where expenditure cuts were insufficient to contain deficits. In others (Serbia), expenditures too continued to increase, postponing the needed fiscal adjustment. As a result, the SEE6 average fiscal deficit remained on a rising trajectory and is projected to reach 4.2 percent of GDP in 2013 (Figure 37). In this regard, SEE6 fiscal performance remained worse compared to EU11 countries, whose average un-weighted deficit stood at 3.6 percent of GDP 2013. SEE6 countries with narrowing fiscal deficits in 2013 were those that were able

Chapter 1: Recent Macroeconomic Developments

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 35: Average Structural Fiscal Balance and Economic Growth

Figure 36: Structural Fiscal Balances

percent

percent of GDP 8

4 4 2 2

-2 -4

-2 -6 -4

-8 -10

-6 2000

2002

2004

▬▬ Structural balance

2006

2008

2010

2012

▬▬ Average growth

2005 ▬▬ Albania

2006

2007

2008

2009

2010

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia ▬▬ Montenegro

2011

2012

▬▬ Kosovo

▬▬ Serbia

Source: National governments and World Bank staff calculations. Note: The structural balance refers to the general government cyclically adjusted balance. The cyclically adjusted balance is the fiscal balance adjusted for the effects of the economic cycle using the Hodrick-Prescott (HP) filter.

Figure 37: Fiscal Deficits

Figure 38: Contribution Toward Change in Deficits, 2012–13

percent of GDP 8

6 1

5 4

-1

2 -2

1 0

-3 ALB

JJ 2011

BIH

KOS

JJ 2012

MKD

MNE

SRB

EU11

SEE6

JJ 2013

ALB

BIH

KOS

MKD

MNE

JJ Expenditure contribution JJ Revenue contribution

SRB

SEE6

QQ Change in deficit

Source: World Bank staff calculations.

to cut expenditures (Figure 38). In Bosnia and Herzegovina and Serbia, assuming implementation of the budget plans, spending cuts are projected to more than offset revenue shortfalls and contribute to reducing fiscal deficits by between 0.5 and 3 percent of GDP. In Serbia, the fiscal deficit is projected to narrow from 7 to 6.5 percent of GDP.

Kosovo’s fiscal deficit is projected to decline to 2.4 percent of GDP, down from 2.7 percent. In Kosovo, the introduction of a fiscal rule sets a statutory maximum deficit at 2 percent of GDP from 2014 onwards. In contrast, in Albania, the deficit is expected to increase by 2.5 percentage points of GDP in 2013 (relative to the original target) reaching 5.9 percent, on

22 |

Chapter 1: Recent Macroeconomic Developments

SLOW ROAD TO RECOVERY

account of slippages in revenue collection as well as increased election-related spending. A weak tax base and an inefficient tax administration further burdened the fiscal adjustment by dampening revenues in SEE6. The average revenue-to-GDP ratio fell from 37 percent in 2008 to 35.1 percent in 2012, despite the resumption of growth. Weak tax collections affected negatively SEE6’s Figure 39: Public Expenditure percent of GDP 60 50 40 30 20 10 0 ALB

BIH

JJ 2011

KOS

MKD

JJ 2012

MNE

SRB

EU11

SEE6

JJ 2013

Source: National authorities, Eurostat and staff calculations.

Figure 40: Contribution Toward Change in Spending, 2009–12

fiscal balances. Despite the recent increases in VAT rates and excises in some countries, which yielded additional revenues (notably Montenegro and Serbia), revenues in SEE6 decreased by an average of around 0.6 percent of GDP in 2013. The main factors behind the weak SEE6 revenues seemed to be partly structural (weak tax administration and custom revenues) and partly cyclical, reflecting depressed demand and lower VAT revenues. The large fiscal imbalances in SEE6 were fueled by a rigid structure of public expenditures, concentrated on public wages and social transfers (Figure 39). On average, the SEE6 countries’ wage bill is very high at over 9 percent of GDP in 2012, and was still rising from pre-crisis levels (Figure 40 and Figure 41). Social transfers, comprising lastresort social assistance, pensions and warrelated benefits, among others, at 12.5 percent of GDP, remained large and poorly targeted, failing to protect the poor (Figure 42 and Figure 43). In Bosnia and Herzegovina, over 12 percent of social benefits were estimated Figure 41: Wage Bill and Social Benefit Spending, 2012 percent of GDP

4 25

2 0

-2 -4

-6

-8 5

-10 -12

0 ALB

JJ CoE

BIH

KOS

JJ G&S JJ Interest

JJ Social benefits

JJ Other

Source: World Bank staff estimates.

MKD

MNE

JJ Subsidies

JJ Grants

JJ Capital

QQ Total

SRB

ALB

BIH

KOS

JJ Compensation of employees

MKD

MNE

SRB

JJ Social benefits

Source: World Bank staff estimates.

Chapter 1: Recent Macroeconomic Developments

| 23

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure 42: Benefits Coverage of Households

Figure 43: Benefits to Top and Bottom Quintiles Households

percent

14 12

10 5 0 ALB

BIH

KOS

JJ Bottom quintile, lhs

MKD

MNE

SRB

2 0 ALB

QQ Top quintile, rhs

BIH

KOS

JJ Bottom quintile, lhs

MKD

MNE

SRB

QQ Top quintile, rhs

Source: National authorities and Europe and Central Asia Social Protection expenditures and evaluation Database, World Bank. Note: Data are from the following years ALB: 2008; Bosnia and Herzegovina: 2007; KOS: 2009; MKD: 2010; MNE: 2011; SRB: 2010.

to go to the wealthiest quintile and in FYR Macedonia, over 11 percent. By contrast, less than 40 percent of benefits reached the bottom quintile in Bosnia and Herzegovina. There and in Kosovo, war veterans’ benefits took up a large share of social protection budgets but failed to reach the poor and most vulnerable. There is, therefore, ample scope to rationalize social expenditures in this area while increasing

social protection to the poor and prospects for shared prosperity of the bottom quintiles of the population.

Figure 44: General Government Debt without Guarantees

Figure 45: State Guarantees

percent of GDP

Public debt levels continued to rise in 2013 in most SEE6 countries. Average public debt (excluding guarantees) increased from 36.2 percent of GDP in 2011 to 42 percent in 2012 and 44.8 percent of GDP in 2013.

2 0

0 ALB JJ 2011

BIH

KOS

JJ 2012

MKD

MNE

SRB

EU11

SEE6

JJ 2013 (proj.)

Source: World Economic Outlook, April 2013 and Kosovo Ministry of Finance.

24 |

Chapter 1: Recent Macroeconomic Developments

ALB JJ 2012

BIH

KOS

MKD

MNE

JJ 2013 (proj.)

Source: National authorities and World Bank staff estimates.

SRB

SLOW ROAD TO RECOVERY

Levels of public debt remained particularly worrisome in Albania, Montenegro, and Serbia in 2013. Notably, the Albanian public debt is projected to exceed 66 percent of GDP without including the announced payment of arrears, which amount to another 4.1 percent of GDP. State guarantees are non-marginal and can add to public debt pressures (Figure 44 and Figure 45). These reached around 7.5 percent of GDP in 2012, but are projected to fall in 2013, because of a call on a large guarantee in Montenegro. Standard and Poor’s sovereign credit ratings have remained unchanged since June 2013 (Table AI.1).

Chapter 1: Recent Macroeconomic Developments

| 25

SLOW ROAD TO RECOVERY

Chapter 2: Macroeconomic Outlook Weak Growth Ahead

With depressed demand, uncertain export prospects, and significant external risks, the SEE region is expected to grow at the rate of 1.8 percent in 2013, broadly in line with the SEE6 RER June report projection. Bosnia and Herzegovina and Kosovo remain the slowest and the fastest growing SEE6 economies, respectively. Growth prospects for 2013 for FYR Macedonia and Montenegro have been slightly upgraded, while downward revisions were made for Albania, Kosovo, and Serbia (Table 3).

Economic activity is moderating, reflecting major weaknesses in domestic demand, despite the recovering external demand and the surge in exports. The Serbian economy is beginning a sizeable fiscal consolidation to bring its debt to a sustainable level and this is likely to act as a drag on activity. The economies of FYR Macedonia, Kosovo, and Montenegro have some momentum in construction, services, and tourism, but their shares in the regional SEE6 economy is too modest to change the overall regional picture.

Table 3: Economic Growth Rates 2012–14

Thus, the 2014 SEE6 economic growth prospects remain subdued and hinge upon a sustained recovery of external demand. Overall, net exports will continue to drive growth in the short term. However, unfavorable labor market conditions, poor investment climate, and subdued consumption and investment will constrain economic activity. The SEE6 region is projected to grow at a rate of 1.8 in 2014 instead of a previously projected 2.7 percent. The main drag on regional growth is a likely slowdown of the Serbian economy.8 Serbia is now expected to grow only 1 percent in 2014 compared to previously projected 3 percent on the back of declining private

percent

2012 2013f 2014f Albania Bosnia and Herzegovina Kosovo

1.6

1.3

2.1

-1.1

0.8

2.0

2.7

3.0

4.0

FYR Macedonia

-0.4

2.5

3.0

Montenegro

-2.5

1.8

2.5

Serbia

-1.7

2.0

1.0

SEE6

-0.7

1.8

Memo item: Euro Area

-0.6

-0.4

1.1

Source: World Bank staff projections. Note: Weighted average.

The one-time effects of the bounce-back of activity following the recession and improved weather conditions are dissipating, however.

8 Downwards revision of projections for Kosovo’s growth for 2014 is only by marginal 0.1 percentage point.

Chapter 2: Macroeconomic Outlook

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SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

consumption and fiscal consolidation. In contrast to Serbia, economic growth in the other five SEE countries is expected to firm up in 2014 and exceed the pace of economic expansion of 2013. The balance of risks to this outlook is on the downside. Given that the developing and the emerging market economies, including the SEE6, are entering a period of expected global financial tightening, business-as-usual policy stance is no longer an option: policymakers would be well advised to reduce macroeconomic vulnerabilities, rebuild fiscal buffers, and reinvigorate structural reforms geared towards

growth. The main external risks to the SEE6 outlook related to: (i) the pace at which global interest rates are may rise, with the expected tapering of quantitative easing in the U.S., (ii) the Euro Area recovery, and (iii) the potential impact of parent bank exit on the banking systems of SEE6 countries. The internal risks to the SEE6 outlook relate to “reform fatigue,” which may delay policy implementation, and the daunting fiscal challenges to stabilize and reduce public debt in several countries. Also, lack of progress on NPL resolution, and private sector arrears could adversely impact credit recovery and growth prospects.

From Weak to Robust Growth: Improving Productivity and Competitiveness Beyond this difficult short-term horizon, how can SEE6 raise their longer-term growth prospects? Maintaining macroeconomic stability remains a top policy priority: SEE6 countries, in particular those with high public debts, would need to step up fiscal adjustment and rebuild fiscal buffers, especially in view of the likely rise in their sovereign borrowing costs due to changes in international market conditions (e.g. US tapering of quantitative easing). Equally important, structural reforms will have to be pursued with vigor. The nascent export-led growth is a positive development, but sustaining it will be a challenge. The SEE6 need to improve their fiscal positions, decrease public debts, and strengthen banking systems while facing significant structural challenges in improving productivity and competitiveness, including in the areas of the investment climate, the labor market, and the public sector.

28 |

Chapter 2: Macroeconomic Outlook

SEE6 region still does not fare well on most comparative metrics on the structural reforms. With major progress in reducing the cost of doing business, FYR Macedonia has started to attract modest FDI flows. The SEE6 countries have major advantages compared to many other developing countries: their reforms are anchored in the EU-accession process and they are located right next to one of the world’s largest economic blocks. Furthermore, the recent agreement between Serbia and Kosovo has heralded greater stability and security in the region. Croatia’s accession to the EU (Box 3), the opening of the accession process of Serbia and Montenegro, as well as recent political changes in the region, may provide a renewed impetus for reforms and future prosperity for the region. The time to use that opportunity is now.

SLOW ROAD TO RECOVERY

Box 3: Implications of Croatia’s EU Accession for SEE6 Following the Croatia’s accession to the EU, the Central Europe Free Trade Agreement (CEFTA) had to be amended. On July 1, 2013, the new trade regime between the SEE6 and Croatia introduced an asymmetric trade liberalization regime. That means that the SEE6 countries retained the custom-free export preferences to the Croatian market as regulated under the EU Stabilization and Association Agreements. However, Croatian exports are subject to tariffs applied to the EU products. Current exports to CEFTA countries comprise 20 percent of total Croatian exports. In 2012, Croatia exported products worth EUR1.66 billion, twice as much as was imported from CEFTA to Croatia. Croatian companies have lost some competitive edge—the most affected being tobacco and agricultural products. For example, Agrokor Ltd. (focusing on food processing, wine and agribusiness), had to transfer 18 percent of its EUR1.38 billion worth of investments into the SEE6 region (since 1993) in 2012, ahead of the Croatian accession to the EU. Serbia has experienced a rise in investments from Croatian firms in the year before accession. For the SEE6 countries, wine, beef, sugar and fish export will be limited to a certain quota, while other agricultural products will be dutyfree under the EU Stabilization and Association agreement although subject to higher phytosanitary and veterinary standards harmonized with the EU. The EC has launched a discussion with CEFTA members on the Article 7 in the CEFTA Stabilization and Association Agreement, which implies mitigation of prescribed conditions and a reduction of high rates. However, it may take time for Croatia to restore to their previous level the trade flows affected by the exit from the CEFTA area, if they can be restored at all. Croatian companies that had been present in the SEE6 markets, in particular in the food industry, have transferred part of their production to SEE6 to mitigate the impact of tariff barriers.

The road to robust long-term growth passes through gains in productivity and competitiveness. In this issue of the RER, one such area is highlighted––improving the business environment, which will help dismantle barriers to the expansion of businesses and ease the burden on private investment.

Improved Business Climate, but Further Reforms Needed

The SEE6 countries continued to remove regulatory obstacles to business. The index for the overall ease of doing business, as measured by the latest Doing Business Indicators, improved in the SEE6 countries from 60.4 in 2009 to 64.9 in 2013. The increase was larger than the EU11’s progress of 3.4 percentage points, though the SEE6 average still remained below that of the EU11. In 2013, Kosovo and FYR Macedonia recorded the largest improvements in the SEE6 region, with 9.8 and 9.1 percentage points, respectively (albeit in Kosovo these were

Chapter 2: Macroeconomic Outlook

| 29

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

from a low basis compared to 2010). Albania, on the other hand, remained the only country in the region with a deteriorating position despite its recent marginal progress (Figure 46). Bosnia and Herzegovina is the worst performer in the region and needs to catch up rapidly with its neighbors if it is to attract investments and improve its economic growth. Figure 46: Distance to Frontier on the Ease of Doing Business, 2009–13 distance to the frontier (best practice=100) 80 75 70 65 60 55 50 ALB JJ 2009

BIH

KOS

JJ 2010

MKD

MNE

JJ 2011

SRB JJ 2012

SEE6

EU11

JJ 2013

Source: World Bank Doing Business Report, 2013.

position from 46.6 to 55 in 2013. The SEE6 progress primarily came from Kosovo and FYR Macedonia, with the latter becoming a regional leader with its position improving to 80.4 in 2013 with respect to the world’s best practice. However, despite this progress, further reforms are needed to address the structural rigidities and increase the competitiveness of the region. For example, resolving insolvency remained the weakest area for the SEE6 group with only 2.5 percentage points of moderate improvement in the ranking between 2009 and 2013. While all six countries made some improvements between 2009 and 2013, the progress is insufficient to engender effective insolvency procedures. In addition, the areas of enforcing contracts and protecting property rights remained particularly burdensome (Figure 47). Figure 47: SEE6 Distance to the Frontier in the Areas of Doing Business, 2009 vs. 2013 distance to the best practice (best practice=100) 100

30 |

Chapter 2: Macroeconomic Outlook

80 60 40 20

JJ 2009

Overall

Starting a business

Getting credit

Registering property

Trading across borders

Getting electr.

Paying taxes

Protecting investors

Dealing with constr. permits

Enforcing contracts

0 Resolving insolvency

Specific areas where the SEE6 countries made most progress in the past few years include: starting a business, dealing with construction permits and paying taxes. On the scale of starting a business, SEE6 improved its position relative to the world’s best practice from 78.8 in 2009 to 86.1 in 2013, with Kosovo recording the highest rate of progress among SEE6. In terms of paying taxes, five of the SEE6 countries continued closing their gaps with the world’s best practice between 2009 and 2013, with Montenegro reporting the most and Serbia the least progress. Progress in dealing with construction permits was also remarkable: a gain of 8.3 percentage points between 2009 and 2013, as SEE6 improved its

JJ 2013

Source: World Bank Doing Business Report, 2013.

In sum, while economic growth in the SEE6 region has resumed, the countries need to continue to strengthen their domestic macroeconomic fundamentals and pursue

SLOW ROAD TO RECOVERY

policies that boost productivity and resilience to external turmoil. Shifting from a slow export-led recovery path to a robust growth remains a key policy challenge for SEE6. The first ingredient of success is ensuring lasting and sustainable macroeconomic stability, which in SEE6 means reducing and sustaining moderate levels of fiscal deficits and debt. On the structural policy front, robust long-run growth requires productivity and competitiveness-enhancing reforms, elements of which are highlighted above, in addition to labor market and public sector reforms.

Chapter 2: Macroeconomic Outlookâ&#x20AC;&#x192;

|â&#x20AC;&#x192; 31

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Annex: Macroeconomic Indicators Table AI.1: SEE6: Select Economic Indicators and Projections, 2012–14 2012 2013f 2014f

2012 2013f 2014f

Unemployment rate3 (percent)

Real GDP growth (percent) 1.6

1.3

2.1

Albania

13.0

12.8

-1.1

0.8

2.0

Bosnia and Herzegovina

28.0

27.5

2.7

3.0

4.0

Kosovo

30.9

Macedonia, FYR

-0.4

2.5

3.0

Macedonia, FYR

31.0

28.8

Montenegro

-2.5

1.8

2.5

Montenegro

20.0

19.2

Serbia

-1.7

2.0

1.0

Serbia

24.0

24.1

Albania Bosnia and Herzegovina Kosovo

Fiscal deficit (percent of GDP)

Current account balance (percent of GDP)

Albania

-3.4

-5.9

Albania

Bosnia and Herzegovina

-2.7

-2.0

Kosovo

-2.7

Macedonia, FYR Montenegro Serbia

-10.9

-9.7

Bosnia and Herzegovina

-9.6

-7.5

-2.4

Kosovo

-7.6

-10.7

-3.9

-4.0

Macedonia, FYR

-5.4

-4.3

Montenegro

-7.6

-6.5

Serbia

-3.1

-18.7

-15.0

-10.5

-6.0

External debt (percent of GDP)

Public debt (percent of GDP)

Albania

59.4

66.2

Albania

56.6

56.9

Bosnia and Herzegovina

45.1

44.7

Bosnia and Herzegovina

53.0

54.2

8.4

9.7

7.6

7.2

34.3

35.5

Macedonia, FYR

67.0

66.1

Kosovo Macedonia, FYR

Kosovo

Montenegro

54.0

54.2

Montenegro

Serbia

50.6

55.9

Serbia

119.2 113.4 86.2

81.0

Consumer price inflation (percent, period average)

1 Excludes guarantees.

Albania

2.0

2.1

2 2013 data shows period average through September except August for Bosnia and Herzegovina.

Bosnia and Herzegovina

2.1

0.7

3 2013 data shows first quarter estimates for Bosnia and Herzegovina; and second quarter for the rest. 2012 data shows annual averages.

Kosovo

2.5

2.2

4 2013 data shows second quarter external debt stock.

Macedonia, FYR

3.3

Montenegro

4.1

2.9

Serbia

7.3

8.2

32 |

Annex: Macroeconomic Indicators

SLOW ROAD TO RECOVERY

Figure AI.1: Real GDP: Percentage Change since Pre-Crisis Peak percent change from 2008

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

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f

▬▬ Albania

▬▬ Kosovo

▬▬ Montenegro

▬▬ FYR Macedonia

▬▬ Bosnia and Herzegovina

▬▬ Serbia

Source: World Bank staff calculations.

Figure AI.2: Real GDP Growth Projections for 2013 projected GDP growth in 2013, percent

percent

Albania

12.5

Bosnia and Herzegovina

10.0

Kosovo

7.5

FYR Macedonia

5.0

Montenegro

2.5

Serbia

SEE6

-2.5

EU11 -5.0 EU15 -7.5 -0.5

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2002

2004

2006

2008

2010

2012 -13f -14f

▬▬ Kosovo

▬▬ FYR Macedonia

▬▬ Montenegro

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ Serbia

Source: World Bank staff projections.

Annex: Macroeconomic Indicators

| 33

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure AI.3: Unemployment Rate H1 2013, percent of labor force (aged 15–64)

percent of labor force (aged 15–64) 40

Albania Bosnia and Herzegovina

Kosovo FYR Macedonia

Montenegro

Serbia 20

SEE6 EU11

EU15 10 0

2006

2007

2008

2009

2010

2011

2012 H1 2013

▬▬ FYR Macedonia

QQ Kosovo

▬▬ Bosnia and Herzegovina

▬▬ Serbia

▬▬ Montenegro

▬▬ Albania

Source: World Bank staff calculations. Notes: Kosovo as of 2012; Bosnia and Herzegovina as of Q1 2013.

Figure AI.4: Fiscal Balance projected 2013, percent of GDP

percent of GDP

Albania

7.5

Bosnia and Herzegovina

5.0

Kosovo 2.5 FYR Macedonia 0

Montenegro

-2.5

Serbia SEE6

-5.5

EU11 -7.5 -7

-6

-5

-4

-3

-2

Source: World Bank staff calculations.

34 |

Annex: Macroeconomic Indicators

-1

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ Bosnia and Herzegovina

▬▬ Kosovo

▬▬ FYR Macedonia

▬▬ Montenegro

▬▬ Albania

▬▬ Serbia

SLOW ROAD TO RECOVERY

Figure AI.5: Public Debt projected 2013, percent of GDP

percent of GDP 80

Albania

70 Bosnia and Herzegovina 60 Kosovo 50 FYR Macedonia

Montenegro

Serbia

20 10

SEE6 0 0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ Albania

▬▬ Montenegro

▬▬ Serbia

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia

▬▬ Kosovo

Source: World Bank staff calculations.

Figure AI.6: Export Growth 2012, percent of GDP

annual growth, percent 50

Albania

Bosnia and Herzegovina

30 Kosovo 20 FYR Macedonia

Montenegro

Serbia

-10

SEE6

-20 -30

EU15 0

-40 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 H1 2013 ▬▬ Serbia

▬▬ Montenegro

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia

▬▬ Kosovo

Source: World Bank staff calculations.

Annex: Macroeconomic Indicators

| 35

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Figure AI.7: Import Growth 2012, percent of GDP

annual growth, percent

Albania

Bosnia and Herzegovina

50 40

Kosovo

FYR Macedonia

Montenegro

10 Serbia 0 SEE6 -10 EU15 0

-20 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 H1 2013 ▬▬ Serbia

▬▬ Montenegro

▬▬ FYR Macedonia

▬▬ Kosovo

▬▬ Albania

▬▬ Bosnia and Herzegovina

Source: World Bank staff calculations.

Figure AI.8: Current Account Balance projected 2013, percent of GDP

percent of GDP

Albania

Bosnia and Herzegovina

Kosovo

FYR Macedonia

-10

Montenegro

-20

Serbia

-30

SEE6 -40 EU11 -50 -20

-15

-10

Source: World Bank staff calculations.

36 |

Annex: Macroeconomic Indicators

-5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f ▬▬ FYR Macedonia

▬▬ Serbia

▬▬ Bosnia and Herzegovina

▬▬ Albania

▬▬ Kosovo

▬▬ Montenegro

SLOW ROAD TO RECOVERY

Figure AI.9: Deposit and Private Credit Growth private credit growth, percent

deposit growth, percent 50

90 80

70 60

40 10 30 20

-10

0 -20

-10 -20

-30 Jun-08

Apr-09

Feb-10

Dec-10

Oct-11

Aug-12

Jun-13

Jun-08

Apr-09

Feb-10

Dec-10

Oct-11

Aug-12

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia

▬▬ Albania

▬▬ Bosnia and Herzegovina

▬▬ FYR Macedonia

▬▬ Serbia

▬▬ Kosovo

▬▬ Montenegro

▬▬ Serbia

▬▬ Kosovo

▬▬ Montenegro

Jun-13

Source: World Bank staff calculations.

Figure AI.10: Non-Performing Loans H1 2013, percent of total loans

percent of total loans 25

Albania Bosnia and Herzegovina

Kosovo

FYR Macedonia

Montenegro 5 Serbia 0 -5

H1 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

▬▬ Albania

▬▬ Montenegro

▬▬ Bosnia and Herzegovina

▬▬ Serbia

▬▬ FYR Macedonia

▬▬ Kosovo

Source: World Bank staff calculations.

Annex: Macroeconomic Indicators

| 37

SOUTH EAST EUROPE REGULAR ECONOMIC REPORT NO.5

Table AI.2: Sovereign credit ratings Dec 2010

Dec 2011

Dec 2012

Sep 2013

ALB

B+

Bosnia and Herzegovina

B+

MKD

BB-

MNE

BB-

SRB

BB-

Source: Standard and Poor’s. Note: Kosovo does not have a credit rating.

Figure AI.11: Ease of Doing Business 2013, proximity to frontier (best practice=100)

proximity to frontier (best practice=100)

Albania

Bosnia and Herzegovina

75 70

Kosovo

FYR Macedonia

Montenegro

55 Serbia 50 SEE6 45 EU11 40 40

Source: World Bank staff calculations.

38 |

Annex: Macroeconomic Indicators

2005

2006

2007

2008

2009

2010

2011

2012

▬▬ FYR Macedonia

▬▬ Montenegro

▬▬ Kosovo

▬▬ Serbia

▬▬ Albania

▬▬ Bosnia and Herzegovina

2013