South East Europe Regular Economic Report No. 4: From Double Dip Recession to Fragile Recovery

After the double-dip recession, as a group the six South East European countries (SEE6) –– Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia –– are now making a fragile recovery. Last year the recession in the Euro-zone had adverse impact on external demand and foreign direct investment (FDI) in SEE6 and the severe winter and a summer drought crippled agriculture and affected trade, energy, and economic activity overall. Now, output is beginning to bounce back. Exports are recovering in Serbia, the largest SEE6 economy; weather conditions are much improved; and in some countries dynamism is revving up in electricity, tourism, and related sectors. However, the recovery in SEE6 is still tentative. In some countries nonperforming loans, sluggish credit recovery, continued de-leveraging, and fiscal consolidation are exerting a drag — and recovery in SEE6 is unlikely to accelerate as long as the Euro-zone remains in recession. Although global economic and financial conditions have continued to improve, the Euro-zone is expected to be in recession in 2013 (at -0.6 percent growth). Global GDP is now projected to expand by 2.2 percent in 2013, 3.0 percent in 2014, and 3.3 percent in 2015. While growth in high-income countries will be a feeble 1.2 percent in 2013 (slowly rising to 2.0 in 2014 and 2.3 percent in 2015), growth in low- and middle-income countries will be 5.1 percent in 2013, accelerating slowly to 5.6 percent in 2014, and 5.7 percent in 2015. Gross capital flows to low- and middle-income countries are 60 percent higher than what they were a year ago — pointing to an end to the most serious effects of Euro-zone de-leveraging on those countries, including the SEE6 economies. Within this context, the SEE6 region is projected to grow 1.7 percent in 2013, signaling the end of the 2012 double-dip recession. Even though growth will in general be fragile, it will be on the upswing in all six countries. Kosovo again is expected to have the highest growth (3.1 percent), thanks to major public investments and a significant inflow of remittances. Next in the growth line is Serbia, at a projected 2 percent, in part reflecting the base effect from last year’s recession. Since Serbia accounts for 45 percent of the region’s economy, growth there is crucial to the region’s performance. Serbia is expected to benefit from increased FDI, solid performance from FIAT, and a return to normal agricultural output, which dropped nearly 20 percent in 2012; and as investors become more confident based on possible opening of EU accession negotiations later in the year, more FDI can be expected. Albania is projected to grow at about 1.8 percent, as it did last year, supported by a steady export performance. FYR Macedonia’s economic growth is expected to be moderate and will come mostly from FDI exports and public investments. Modest growth is expected in Montenegro partly because electricity and agriculture are recovering but mainly because tourism is surging ahead. In Bosnia and Herzegovina growth is likely to be tepid this year; the projection is just 0.5 percent. Unfortunately, numerous issues related to the BIH business environment will continue to constrain FDI flows there, as well as the prospects for expansion of domestic businesses. Against the backdrop of this tentative and fragile recovery, SEE6 countries should, as argued in the last report, intensify their efforts to reform structural areas. Fiscal consolidation efforts should become easier now that the output and revenue outlook is improving. The investment climate needs to be improved substantially, especially in the main areas of weaknesses: construction permits and licenses, barriers to entrepreneurship, and skills and infrastructure. Its neighbors could learn from FYR Macedonia, which continues to have the most favorable investment climate in the region as measured by the Doing Business indicators. One of the main worries in this nascent recovery is that SEE6 economies are plagued by high unemployment, especially youth unemployment, and they are not creating jobs fast enough to absorb new entrants into the labor force. In fact, the jobs situation is worse than the dismal unemployment figures suggest because so many leave the region to work elsewhere. In part, this is the legacy of periods when some SEE6 countries suffered significantly from regional dislocations that delayed reforms. Emigration continues as the current environment for doing business exacerbates the difficult labor market conditions. What SEE6 countries now need to do is to sustain the fragile recovery and push for job creation. This will require aggressive job-oriented policies. Recent World Bank research on jobs in low- and middle-income countries in Europe and Central Asia suggests that the policy agenda for job creation would best be targeted to four areas: fostering entrepreneurship, improving skills, managing internal and international mobility, and reducing institutional disincentives to job creation. Accelerating reforms in these areas is imperative if there is to be hope for more, better, and more diverse jobs in SEE6 countries.