World Bank Projects Sluggish Growth for the South East European Economies in 2011 and 2012

While the region has made significant progress over recent years, it is at risk from the effects of a further global slowdown and needs to adopt policies that support stability and longer term growth   

SARAJEVO, November 15, 2011 – While a global slowdown and recent turbulence in the Euro zone (EZ) have shaken economies of the six countries in South East Europe (SEE6)[1], their deeper integration with the European Union (EU) remains the best long term prospect for their growth, according to the new World Bank “South East Europe Regular Economic Report” (SEE RER), released today.

This is the first of a series of regular reports which will come out semi-annually.   “Our projections are for the growth in this region of 2.5 percent in 2011 and 2.1 percent in 2012,” says Ron Hood, Lead Economist in the World Bank’s Poverty Reduction and Economic Management Sector Unit in the Europe and Central Asia region and lead author of the report. “However, even these modest growth projections assume that the Eurozone crisis is solved in an orderly manner. Should the crisis worsen, economic growth in these countries could be much worse.”  The effects of a further global slowdown and the prolonged uncertainties around the Eurozone crisis will influence SEE6 economies through trade, foreign direct investment (FDI), foreign banks, and remittances, according to the report.  

All these transmission channels would be affected by deeper economic and financial tensions in the EU and the Eurozone.  Trade with the EU is a key driver of exports and overall economic growth for SEE6 countries, amounting to between 30 percent and almost half of their GDP. In 2010, 58.2 percent of total SEE6 exports were to the EU, with the lion’s share going to Italy and Germany. After a drop by 14.7 percent in 2009, exports marked a robust growth by 20 percent in 2010, peaked at 29.7 percent in the first quarter of 2011 year on year, and have subsequently slowed. Imports have a similar dynamics but with a deeper decline in 2009 and a more muted recovery. As a consequence, both the trade balance and the current account deficit (CAD) for the region improved by about 10 percentage points in 2010 compared to 2008. However, despite recent improvements CADs still remain high, particularly in Montenegro and Kosovo, says the report. 

Beyond trade, EU investors are also the largest aggregate provider of FDI to the region, with net inflows worth over 2 percent of the Western Balkans GDP. Likewise, Eurozone countries represent a significant source of remittances to all the SEE6 countries, particularly for Kosovo, Albania, Bosnia and Herzegovina, and Serbia. The presence of foreign banks creates another channel of potential influence. The share of foreign banks in the total assets of the region’s banking system stands at around 89 percent. “Whereas overall banking systems in SEE6 countries appear resilient, with high liquidity and significant capital buffers, existing credit and funding risks are being magnified in the region, driven primarily by adverse developments in the EU, an overhang of non-performing loans from banks in many SEE6 countries, and slowing economic growth,” warns Hood.

“Almost all foreign banks in SEE6 are from EU countries, with a comparatively high share of Greek and Italian owned banks. Further stress on their respective parent banks could potentially create another credit crunch in the region.” Hood emphasizes that, “Financing is likely to be a constraint going forward. External debt has grown and a decline in SEE6 growth may cut government revenues, raising pressures on public finance.”  The report recommends that authorities in SEE6 countries pursue fiscal prudence, rebuild fiscal buffers, and be prepared for further expenditure consolidation. Unfortunately, the fiscal performance has deteriorated in all countries since 2008, and few countries in the region still have room to accommodate a worsening of the crisis through allowing automatic stabilizers to operate. With the exception of Kosovo, no country has sizable deposits to draw down. Thus several countries should accelerate fiscal consolidation, with pensions and wage bills being important areas of focus, says the report. While immediate financing needs of fiscal deficits appear to have been secured, longer term prospects will remain difficult, warns the SEE RER.

The sharp rise of gross external and government debt to GDP between 2008 and 2010 is mainly attributed to government borrowing aimed at financing fiscal deficits used to smooth out crisis effects. The SEE6 group is heterogeneous regarding the level of external debt, with the total debt in Montenegro and Serbia above the regional average, while Albania has the biggest public debt as a percentage of GDP. Improving employment opportunities remains another major long term challenge for the SEE6, concludes the report. The high level of unemployment among youth and the low participation of women is a striking feature of the SEE6 labor market. Moreover, much of the unemployment is long term and several countries have aging populations. “Future growth will need to be driven more by investment and improvements in productivity that enhance competitiveness and productive capacity, rather than by the externally financed consumption and investment in real estate and other bubble assets,” says Jane Armitage, World Bank Country Director and Regional Coordinator for South East Europe.

“Countries in South East Europe need to address longstanding structural reform challenges. This will allow them to take better advantage of the access to markets, inflows of foreign direct investment, bank finance, and remittances that closer integration with the EU offers.” The special feature of the report is the focus on education, and on Research and Development (R&D) and Innovation.