Western Balkans is heading towards another storm

Just as the economies of the Western Balkans have been looking to sustain recovery from the COVID shock, the region is now facing a new set of challenges. The war in Ukraine, and the resulting sharp increase in energy prices, coupled with slowing global growth and shrinking global financial resources, is severely affecting economic performance in all six economies — Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia — Despite a strong start to the first six months of 2022.

Indeed, during the first half of 2022, employment levels reached historic highs in many countries. The region’s average employment rate is now 46 percent, up 3 percentage points from last year. All sectors contributed to the recovery in the labor market, with services (including tourism) playing a particularly strong role. As a result, labor shortage has emerged as a major concern highlighted by companies across the region.

The unemployment rate in the Western Balkans also fell to a historic low of 13.5 percent by mid-2022, moving about 151,000 people out of unemployment into jobs. Encouragingly, the broad-based recovery in the labor market has also benefited vulnerable groups and lifted an equivalent number of people out of poverty. Youth unemployment also reached a record low of 27.1 percent, while labor force participation among women increased to 53.0 percent by mid-2022 (an increase of 2.6 percentage points).

The area is heading towards another storm

Figure 1. Growth rates in the Western Balkans have been revised downward again since spring 2022 (real growth, %)

Source: World Bank staff calculations

However, the region is now facing a series of adverse shocks. The six countries are close to the eye of the storm in terms of the global energy crisis, and the war in Ukraine, but without the protective umbrella that advanced economies and countries within the European Union can provide for their vulnerable populations. Rising energy and food prices have pushed inflation to levels not seen in decades, eroding purchasing power and business confidence. High inflation affects those who are relatively less affluent compared to other income groups, and that could erase recent gains in poverty reduction. The region’s export boom has begun to slow, just as import costs have risen sharply due to higher commodity prices, causing the current account deficit to widen sharply, putting pressure on currencies and foreign exchange reserves. The latest data also indicates that the labor market is starting to soften with employment growth slowing amid rising inflation and increasing uncertainty. Monetary tightening needed to curb inflation is driving up financing costs and dampening demand, including in the region’s main trading partners.

This powerful combination of supply and demand shocks weighs heavily on the region’s outlook, keeping inflation high and dampening consumer and investor confidence. Economic activity is slowing sharply in advanced economies, particularly in the Eurozone, which is a major source of demand for Western Balkan goods and services, and a source of investment and remittances. As a result, growth in the Western Balkans was revised further downward for 2023 (Figure 1).

Looking beyond crises

Governments are facing severe financial pressures due to a combination of energy relief needs and rising financing costs. This is happening at a time when fiscal buffers are already being depleted due to COVID policy support and tightening financing conditions. Yields on outstanding Eurobonds issued by Western Balkan countries expanded significantly in 2022, with some approaching 10%. Financial risks must be watched closely as power generation and distribution companies struggle to finance their operations and in many countries are prevented from fully charging higher costs to end users. The fiscal deficit is expected to widen, and public debt to rise.

Figure 2. Structural reforms needed to boost potential growth in the Western Balkans (GDP growth, %)

Figure 2

Sources: Penn World Tables; United Nations Population Prospects; world bank; World Bank, WDI. Note: ECA = Europe and Central Asia; Emerging Market Countries and Developing Countries = Emerging Market Economies and Developing Countries; WBK = Western Balkans. Shaded area indicates projections. GDP weights are calculated using average real GDP in US dollars (averaged 2010-19 prices and market exchange rates) for the period 2011-19.

In the short term, governments should prioritize policy support for vulnerable groups, and ensure that measures are targeted and time-bound to reduce fiscal risks. But at the same time, with limited fiscal space, no-nonsense reforms that will boost growth over the medium term at limited fiscal cost must be a priority. Given the strong headwinds to long-term growth prospects, it will be critical for economies in the Western Balkans to promote structural reforms and accelerate economic transformation. Convergence with European counterparts is only possible for the countries of the Western Balkans if the potential growth rate increases.

At a time when public sector resources are scarce, it would be appropriate to prioritize reforms at a limited financial cost that would accelerate potential growth and convergence in the medium term (Figure 2). This will include measures to raise standards of governance, including digitization, increasing the level of competition in the market, removing barriers to entry into business, increasing retention and reinvestment among foreign investors to enhance factor productivity, as well as improving skills and reducing barriers to female employment. The power of sharing. The ongoing crisis also underscores the importance of accelerating the region’s green transition away from volatile hydrocarbons towards cleaner electricity generation, as well as greener production, financing and consumption patterns.

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