South East Europe Regional Economic Report (SEE RER) No. 2 Poverty Reduction and Economic Management (PREM) Europe and Central Asia (ECA) Region The World Bank June 5, 2012

Outline I.SEE6: DEVELOPMENTS, OUTLOOK, CHALLENGES I.TOWARD ‘GOLDEN GROWTH’ IN SEE6

I. SEE6: DEVELOPMENTS, OUTLOOK, CHALLENGES: Global context The world still faces several challenges. higher oil prices, reduced capital inflows, high-income country fiscal and banking-sector consolidation Most developing economies have fully recovered from the crisis. But second half of 2011 saw slowdown generating major uncertainty for global economy going forward with possible further contagion. Early 2012 signals positive, but turmoil in May Risk of intensification of the Greek crisis and wider contagion

Global industrial production and imports improved in early 2012

But financial uncertainty increased in May

RECENT DEVELOPMENTS IN SEE6 In contrast to many developing countries, SEE6 show a sluggish real output recovery Significant external adjustment But rise in debt, especially public debt Labor market – a significant problem Credit market – improving but slowly Poverty reduction: sluggish Unexploited potential: exports

SEE6 Real Output Recovery (20018 real GDP index=100) ALB, KOS, MKD well underway BIH, MNE, SRB lagging. Why?

It’s partly investment… Except in MKD and KOS

But consumption and exports are weak as well Consumption, 2008=100 Exports, 2008=100

SEE6 region has shifted from trade-led to domestic- demand-led growth, but demand remains sluggish…

…as reflected in falling inflation rates, despite higher energy prices

…with remittances providing an economic and social cushion

Big unexploited potential: exports

But total public and private external debt getting too high

…especially public debt (except in KOS) (% of GDP)

A (temporary?) external relief: 5 year spreads of major parent banks (basis points) and Vienna 2.0

Deposits mostly recovered to pre-crisis level……

…but credit growth has not (nominal y-o-y growth)

…and the reason is mostly NPLs

Changes in unemployment rate are worrisome (percentage points, 2011/2008)

Levels are high especially in KOS, MKD, BIH (unemployment rates)

A real worry: Specter of Jobless Growth (Change in real GDP and employment in SEE6 (left) and MKD (quarterly) in 2011)

Poverty rates are high ($2.5-5 ppp)

After income losses in , growth has not exactly been pro-poor, except perhaps in MNE

And LITS suggest, people feel severely affected by the crisis, especially in Serbia..

…mainly via loss of work hours, job or closure of business

…forcing people to cope, mainly by cutting “luxuries” and even food

OUTLOOK FOR SEE6 GLOBAL OUTLOOK--Bottom will come in 2012, growth weak thereafter

Outlook: SEE6 Growth Will Bottom Out in 2012 at 1.1% before recovering to 2.6% in 2013 Real GDP growth (%) ALB BIH KOS MK MNE SRB SEE

Key policy challenges in : Fiscal and Public Debt Slower growth in 2012 Revenue underperformance Public debt level and dynamics MNE, SERB, ALB Wage bill and pensions (esp. BIH) Financial discipline and public sector arrears (MNE, ALB, MKD) Elections in SERB, MNE (2012) and ALB, MKD (2013)

Special Fiscal issues: Arrears and Guarantees Arrears emerging in SEE6 Private sector (MNE, ALB, MKD) Public sector (ALB, MKD); Municipal (MNE) Combination of weakness in revenue administration, control over municipal finances, commitment controls, credit tightness State guarantees--important in some countries (e.g., MNE, SRB)

Real GDP per capita index (North and Continental Europe = 100)

II.Reasons for optimism: Toward “golden growth” – SEE6 countries are becoming more integrated with Western Europe and the world – SEE6 countries substantially increased their external trade and trade sophistication – European “convergence machine”—reduction in income per capita gap with Western Europe – is available to SEE6, but with structural reforms – But aging and shrinking workforce a major challenge – Taking advantage of trade and financial flows – SEE6 catching up but limited innovation, R&D – Reforming labor and government—key challenges

In Sum and the Policy Agenda 2012 – Difficult year; risks of contagion Short-term challenges: Fiscal, Financial, and Social – Public debt, arrears and guarantees, financial – credit market, unemployment and poverty Long-term challenges: Reforming labor and public sectors SEE6 reforms anchored in the European future