Overlapping crises in the Western Balkans
The Western Balkan countries are facing a series of economic shocks simultaneously. The region’s economy was just beginning to rebound from the COVID-19-induced recession, but now also faces the fallout from the war in Ukraine, a resurgence of inflation and an urgent energy transition. Getting through these crises involves risks and will require careful choices.
The six Western Balkan economies – Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia – experienced strong economic recovery with 7.4% growth in 2021 as the region rebounded from the 2020 recession. In fact, the strength of the recovery has exceeded expectations due to a combination of pent-up consumer demand, an easing of travel restrictions despite high infection rates and low vaccination, and a rebound in investment and an increase in exports, all helped by continued fiscal support. A return to economic growth has led to job creation, which has helped reduce poverty in the region.
Tax revenues have also rebounded in 2021 as growth resumes, reducing budget deficits and public debt. However, one year of growth is simply not enough for a country to rebuild its fiscal and debt buffers for the next shock, if it is large. Public debt fell to 57% of GDP in 2021, about 4 percentage points lower than the 2020 peak, but still higher from 50% in 2019 before COVID-19. As a result, Western Balkan governments entered 2022 with room to manoeuvre.
Even before the outbreak of war between Russia and Ukraine, economic growth in the Western Balkans was already slowing towards pre-crisis rates, and similarly inflation was already rising as supply constraints and the pent-up demand around the world drove up commodity prices. The war in Ukraine is exacerbating these two tendencies and also pushing up inflation. It is also shaking business and consumer confidence, impacting trade and tourism, and causing serious disruptions in food and energy supply chains. This is particularly the case in Serbia and Montenegro, which are the Western Balkan economies most exposed to trade with Russia and Ukraine.
Upcoming test time
The Western Balkans now face particularly uncertain prospects. In addition to the outbreak of war, COVID-19 has not gone away and the energy disruptions caused by the war in Ukraine have highlighted the vulnerabilities associated with the region’s heavy reliance on fossil fuels. While we expected a continued strong rebound in 2022 as most epidemiological measures were lifted and pent-up demand boosted consumption and investment growth, the war disrupted this trajectory. In our stream reference scenario, we expect real output to grow by 3.1% in 2022, a downward revision of almost 1 percentage point, and below the historical growth rate. Additionally, further growth downgrades and higher inflation forecasts are likely as conflict drags on into summer 2022, sanctions intensify, and the growth of the EU slows further (chart 1).
Not only is the region facing slower growth, but rising food and energy prices mean that the poorest households who spend more than 60% of their budget on food and energy experience a particularly high rate of inflation (Figure 2). They often lack the coping mechanisms to absorb a higher cost of living.
Political compromises in a context of uncertainty
Western Balkan economies have weathered the COVID-19 shock relatively well, as they rebounded faster and stronger than expected, using fiscal policy to support vulnerable households and businesses. However, resources have dried up and a key challenge now is to meet the pressing needs of today, while keeping an eye on the reforms needed to support equitable, greener and sustainable growth tomorrow. Governments will need to be parsimony and prudently use their limited budgetary resources to protect the poorest households who spend a greater share of their income on food and energy. Policy measures to address current pressing needs must be time-limited so that governments can return to buffer replenishment as pressures dissipate. Furthermore, in a resource-scarce environment, now is the time for governments to step up efforts to improve tax compliance, strengthen social support systems to protect the energy poor, and reallocate resources to investments in energy efficiency, as well as enabling private investment in renewable energies. energy.
Finally, governments should not lose sight of the neglected reforms since 2020 which are essential to strengthen long-term potential growth. Structural reforms aimed at improving human capital, supporting labor market participation (particularly for women and youth), and enhancing competition would help boost potential growth that was slowing even before the current crisis. Moreover, attracting greener and higher value-added foreign investment would require greater efforts to streamline trade regulations and boost connectivity and digitalization.