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

-6

-4

-2

0

2

4

6

8

10

12

14

16

2011M01 2011M04 2011M07 2011M10 2012M01

World IP

Developing IP

High Income IP

percent growth, 3m/3m, saar

Source: Datastream and World Bank Prospects Group

-60

-50

-40

-30

-20

-10

0

10

20

30

40

2009M01 2009M06 2009M11 2010M04 2010M09 2011M02 2011M07 2011M12

Industrial Production (3m/3m)

Import Volume (3m/3m)

percent growth, 3m/3m, saar

Source: Datastream and World Bank Prospects Group

But financial uncertainty increased in May

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12

Portugal

Ireland

Spain

Italy

Belgium

5-yr sovereign credit-default swap rates (basis points), Jan 2010-May 2012

Source: Bloomberg and World Bank Prospects Group

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 underwayBIH, 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)

0

10

20

30

40

50

60

70

MNE ALB SRB BIH MKD KOS

2008 2009 2010 2011

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

points) and Vienna 2.0

0

100

200

300

400

500

600

700

RaiffeisenErste

Unicredit

IntesaKBC

SocGen

SEB

Nordea

EBA's recapitalization plan announcement

LTRO1LTRO2

Deposits mostly recovered to pre-crisis level……

20

40

60

80

100

120

140

160D

ec-0

5

Jun-

06

Dec

-06

Jun-

07

Dec

-07

Jun-

08

Dec

-08

Jun-

09

Dec

-09

Jun-

10

Dec

-10

Jun-

11

Dec

-11

ALB BIHKOS MKDMNE SRBSEE6 total

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

-20

-10

0

10

20

30

40

50

60

70

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

ALB

BIH

KOS

MKD

MNE

SRB

SEE6 median

…and the reason is mostly NPLs

0

5

10

15

20

25

30

2007:Q1 2007:Q4 2008:Q3 2009:Q2 2010:Q1 2010:Q4 2011:Q3

ALBBIHKOSMKDMNESRBSEE6 median

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 2008-9, growth has not exactly been pro-poor, except perhaps in MNE

-14

-10

-6-2

26

Annu

al g

row

th ra

te %

1 10 20 30 40 50 60 70 80 90 100Expenditure percentiles

Growth incidence 95% confidence bounds

Growth in mean Growth at median

Mean growth rate

Serbia 2009 - 2010-4

0-2

00

2040

Ann

ual g

row

th ra

te %

1 10 20 30 40 50 60 70 80 90 100Expenditure percentiles

Growth incidence 95% confidence bounds

Growth in mean Growth at median

Mean growth rate

Montenegro 2009-2010

-60

-40

-20

020

Ann

ual g

row

th ra

te %

1 10 20 30 40 50 60 70 80 90 100Expenditure percentiles

Growth incidence 95% confidence bounds

Growth in mean Growth at median

Mean growth rate

FYR Macedonia 2009-2010

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

0 20 40 60 80 100

Serbia

FYROM

BiH

Kosovo

Albania

Montenegro

Source: LiTS II, 2010.

(% of adults)

How much was your HH affected by the crisis?

A great deal A fair amount Just a little Not at all

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

0

10

20

30

40

50

60

70

BiH Kosovo Albania Serbia FYROM MontenegroSource: LiTS II, 2010.

(% of crisis-affected population )

Main crisis impact pathways

Reduction in wages or hours

Job loss or closed business

Reduced flow of remittances

Additional work undertaken

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

0

10

20

30

40

50

60

70

BiH Montenegro Albania Serbia Kosovo FYROMSource: LiTS II, 2010.

(% of adult population)

Main crisis coping mechanisms

Reduced consumption of luxury goods

Reduced consumption of staple foods

Stopped buying medications / postponed doctor visits

Reduced vacations

Reduced consumption of alcohol / cigarettes

Delayed utilities payments / cut TV, phone, or internet

OUTLOOK FOR SEE6GLOBAL OUTLOOK--Bottom will come in

2012, growth weak thereafterReal GDP Growth Assumptions

2010 2011e 2012f 2013f 2014f

World 4.1 2.8 2.5 3.0 3.3

High-income countries 3.0 1.6 1.5 2.0 2.3Developing Countries 7.4 6.2 5.5 5.8 5.7

Memo:Euro Zone -1.8 1.6 -0.3 1.0 1.4

Outlook: SEE6 Growth Will Bottom Out in 2012 at 1.1% before recovering to 2.6% in 2013

Real GDP growth (%)

2012 2013

ALB 1.6 2.5

BIH 0.5 1.5

KOS 4.0 4.1

MK 2.0 3.2

MNE 0.5 1.5

SRB 0.5 3.0

SEE6 1.1 2.6

Key policy challenges in 2012-13: 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