World Bank warns an economic growth slowdown
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- By 2020 the fiscal deficit is projected to increase to 2.1 percent. The rise will be driven by government efforts to clear arrears and the adoption of fiscal incentives such as VAT exemptions, lower income tax rates, and a higher ceiling for the high-income PIT tax bracket.
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TIRANA, Apr. 2- The World Bank made a presentation of its regular economic report on Balkans for Spring 2019 in Tirana on April 2. The report claims that the Western Balkans economies are projected to continue to expand in 2019-2020, but this stable outlook is vulnerable to growing external and domestic risks. The growth is projected to average 3.7 percent during the 2019-2020 period.
In 2018 economic growth in the Western Balkans reached 3.8 percent, supported by increased public spending, and in Albania and North Macedonia also by a rise in net exports. The report writes that growth will differ by country, accelerating in Bosnia and Herzegovina, Kosovo, and North Macedonia, while decelerating in Albania, Montenegro, and Serbia. Factors common to all countries are the recent fiscal stimuli and favorable external conditions that pushed growth in 2018, beyond its potential in some of them. The waning effects of these factors challenges the medium-term growth outlook in the region.
Moreover, there is growing public discontent in several countries which could lead to higher political uncertainty and a slower pace of structural reforms. Western Balkan countries are also confronted with growing external risks from slower-than-projected growth in the EU, geopolitical and trade disputes, and a possible tightening of financing conditions in international capital markets. Against this backdrop, there is an opportunity to advance reforms to mitigate risks and the demands for greater economic opportunities.
Despite stronger growth in 2018, the pace of job creation slowed, reflecting limited private sector dynamism. In 2018, 96,000 jobs were created mostly in industry and services in the Western Balkans, down considerably from 171,200 jobs created during 2017. The slower labor market response reflects to some extent the temporary effects of the fiscal stimuli that pushed growth but did not encourage private sector job creation. Unemployment fell in 2018 but remains high, particularly for women and the youth; in some countries the fall in unemployment stemmed from increased labor inactivity and emigration rather than new jobs. Labor market distortions at the country level remain evident in regional and gender disparities. Reducing disincentives to employment and labor force participation, such as the high burden of taxes on low-wage earners, is critical to spur job creation and growth.
Ensuring that firms can readily enter, compete on equal terms, and efficiently exit the market, would support business development and attract private investment in the Western Balkans. In recent years, inflows of foreign direct investment (FDI) have helped transform industries and increase exports, but FDI is still low as a share of GDP and its growth is slow. Regulatory barriers make it difficult for existing firms to expand, become more productive, or exit the market, and for new firms to emerge and succeed, or fail fast and cheap. High-growth firms (that grow on average by at least 20 percent for three consecutive years), create the most jobs in the Western Balkans, but there are few of these firms: in 2016 only 1 in 33 formal sector firms in North Macedonia and, in 2017, only 1 in 20 in Serbia had average growth of at least 20 percent for three consecutive years. Other small transition economies in Europe, such as Latvia, Lithuania, and Estonia, as well as other emerging markets have much larger shares of high-growth firms. Reinforcing the public institutions that ensure no one benefits from special treatment would encourage entrepreneurs to enter the market and innovate, expanding the pool of younger, more productive firms that grow and create jobs.
Because public spending is dominated by large public wage bills and untargeted social programs, the efficiency of fiscal policy needs to improve. Countries that have been committed to fiscal consolidation such as Albania and Serbia are seeing their debt go down, and it is critical to safeguard these gains. But public and publicly guaranteed debt remains high in most countries, and rose in Montenegro, North Macedonia, and Kosovo in 2018. Fiscal risks related to pensions, municipal finances, and state-owned enterprises are also on the rise. Improving the efficiency and equity of public spending as well as strengthening revenue mobilization remain priorities for fiscal policy to reduce the high debt levels, create fiscal buffers to mitigate risks, and improve the delivery of public services in the Western Balkans.
Harnessing the opportunity to build reform momentum at a time of a stable outlook is essential for strengthening the foundations for future growth. This edition of the Western Balkans Regular Economic Report discusses selected reform areas that will help boost productivity for faster and sustained growth and jobs, namely (1) competition policy; (2) labor taxation; (3) the distributional impact of personal income taxation; (4) financial sector diversification; (5) export sophistication; and (6) economic connectivity. Advancing reforms in these and other areas would allow Western Balkan countries to seize the opportunities that EU accession can bring, and to be able to compete on an equal footing with EU peers.
This report features a special focus section on human capital development. The region has achieved notable progress in expanding access to basic education and health and setting up social protection systems to protect the vulnerable. This Focus Section explores how Western Balkan societies can be better prepared to take advantage of the opportunities offered by rapid technological changes, mitigate risks, and create dynamic growing economies where young people can thrive and realize their aspirations. Unaddressed, the region’s human capital challenges will severely limit the region’s prospects for growth and poverty reduction. For instance, too little investment in early childhood development translates into poor performance in primary and secondary education in some countries. In school, students in some countries do not acquire the skills they need to function effectively as labor markets become ever more competitive. Poor quality technical and university education makes the transition from school to work difficult; many graduates who suffer years of unemployment cannot build work experience. Social assistance programs also do not give vulnerable households the support they need to prepare them for the labor market. Inefficient health systems are unable to address the rise of noncommunicable diseases, and individual out-of-pocket spending on health is high. In general, countries in the region must act boldly to build human capital.
All the risks the region is facing regardless of the improvements, might negatively affect their progress towards the European reforms for economic and social growth, that would eventually lead them to either accession or candidacy for accession in the Union. The public debt and overdue arrears were reduced by 68.8 percent of the region’s GDP helped by the reduction of the expenditure ratio to GDP and exchange rate appreciation.
World Bank’s Country Manager for Albania Maryam Salim said based on the report that the external and fiscal imbalances have improved, jobs have increased, and public debt has decreased. However, a faster pace of structural reforms is required to maintain fiscal consolidation, mitigate fiscal risks and accelerate energy sector reforms to protect fiscal sustainability. Improving the business climate and law enforcement remain priorities pursued by increased investment in infrastructure and human capital.
“Despite these improvements, further sustainability of growth would require a faster pace of structural reforms and progress for EU accession,” said Salim.
Albania’s overview
The report claims that in Kosovo and Albania, growth reached an estimated 4.2 percent. In Kosovo, it was driven by a rise in public infrastructure investment and by a consumption rebound due to higher public wages, remittances, and consumer lending. In Albania, a rise in energy production due to exceptionally favorable hydrological conditions which doubled in the first nine months of 2018, explained half of total GDP growth, which was further supported by growth in tourism services and household consumption driven by higher employment and wages.
Tourism boosted growth of services; the number of foreign citizens visiting the country for leisure rose by 15.9 percent year-on-year in 2018. On the spending side, consumption contributed 1.9 percentage points to estimated growth, supported by higher employment and wages. Net exports, especially of energy and services, contributed 1.3 percentage points. Private investment moderated due to the winding down of two large energy projects financed by foreign direct investment (FDI), but public investments in infrastructure speeded up. By year-end the contribution of investment to growth was 1 percentage points.
Growth supported job creation in all sectors, and with more Albanians participating in the labor force, unemployment went down. Average employment growth in 2018 was strongest in industry (4.7 percent year-on-year) and services (4.2 percent). The labor market dynamics encouraged job searchers and entry into the labor force, despite a four-year drain on the working-age population due to emigration. However, labor force participation is still low at 59.4 percent, and there are major gaps between male and female participation rates. The unemployment rate, after declining for 11 consecutive quarters, slightly increased by 0.1 percentage points at 12.3 percent at the end of the year. Youth unemployment rate fell by 2.3 percentage points year-on-year. The average real wage increased by 1.6 percent at the end of 2018.
Minimal inflationary pressures prompted an easing of monetary policy, in line with the Bank of Albania’s (BoA) price stability framework. Headline inflation of 1.8 percent at year-end 2018 was below the BoA’s 3 percent target. Inflation dynamics during the year reflected mostly food prices, with some passthrough effects resulting from the exchange rate appreciation in the second half of the year. Inflationary trends as indicated by core inflation (0.4 percent at year-end) show little demand pressure. After the exchange rate appreciation, the BoA intervened in the foreign exchange market and in June eased monetary policy by taking the policy rate to a record low of 1 percent; the change was transmitted to short-term government securities and, to a lesser extent, deposit and lending rates. Through 2018 the lek appreciated by about 5 percent against the euro.
The banking system is well-capitalized and liquid, but credit to the private sector continued to contract. As the BoA continued its efforts to reduce nonperforming loans, they had fallen to 11.1 percent of total loans by December 2018. Despite monetary easing, credit to the private sector as a share of GDP fell by 2 percent (year-on-year). The main cause was the decline of credit in foreign currency and related exchange rate dynamics; credit in local currency mostly went to households and SMEs (small and medium-sized enterprises). Deleveraging by EU-owned banks is constraining credit supply, and on the demand side, BoA surveys indicate that firms and households have little interest in borrowing.
Fiscal consolidation has helped to reduce public debt. Now there is a need to address such fiscal risks as contingent liabilities from public-private partnerships (PPPs) and from state-owned enterprises (SOEs). Fiscal consolidation efforts continued in 2018 in the form of spending restraints. Revenues declined from 27.7 percent of GDP in 2017 to 27.2 percent, partly due to the clearance of accumulated value added tax (VAT) refund arrears and to the effect of the exchange rate appreciation on VAT on imported goods. However, personal income tax (PIT) revenue and social security contributions rose slightly, supported by wage increases and measures to reduce informality. With revenue underperforming, curbs on the wage bill and social benefits brought current spending as a share of GDP down from 25.3 percent in 2017 to 24.3 percent. Capital spending went up slightly, by 0.3 percentage points of GDP as new infrastructure projects were launched—PPPs for infrastructure projects rose rapidly. Though PPPs do alleviate funding constraints in the short term, they increase contingent liabilities that may narrow the fiscal space for new investments in later years. Thus PPPs need to be continuously re-evaluated.
Budgetary arrears (e.g., VAT refunds and road infrastructure and local government arrears) amounted to about 1.5 percent of GDP in 2018, thwarting budget execution and undermining the credibility of the fiscal consolidation, with negative effects on private sector growth. The stock of public debt and arrears declined to 68.6 percent of GDP in 2018, mostly due to the exchange rate appreciation, but that is still high and carries risks for debt sustainability in case of adverse shocks. The government successfully placed a seven-year 500 million euros Eurobond at 3.5 percent in October and used 200 million euros to buy back a portion of its 450 million euros 2015 Eurobond expiring in 2020.
Strong exports and slowing growth in imports improved the external position in 2018. The current account deficit (CAD) narrowed from 7.5 percent of GDP in 2017 to 6.3 percent in 2018. The trade deficit narrowed to 13.5 percent of GDP, as rising exports of electricity and services, supported 16.7 percent export growth. FDI grew by 6.4 percent, which fully financed the CAD. Year-end foreign reserve coverage of six-and-a-half months of imports mitigated the risks posed by high external debt of 62.1 percent of GDP.
Outlook and risks
Albania’s economic growth is expected to moderate to 3.7 percent through 2020, with the return of energy production to normal and the completion of major investment projects. Services and construction are expected to lead growth, which will be supported by private consumption fueled by labor income gains, further government investment in infrastructure, and improvement in the business environment. Medium-term projections assume that consumption will continue to grow at about 3.4 percent a year and fixed capital formation at 3 percent. Net exports are also expected to support growth as market access expands, but their contribution is expected to be smaller as imports respond to domestic demand.
By 2020 the fiscal deficit is projected to increase to 2.1 percent. The rise will be driven by government efforts to clear arrears and the adoption of fiscal incentives such as VAT exemptions, lower income tax rates, and a higher ceiling for the high-income PIT tax bracket. Current expenditures on wages, social transfers, and operation and maintenance are expected to be contained as a share of GDP, but capital spending will rise to 4.8 percent. PPPs are expected to finance an increasing share of public projects, some of them already signed in 2018 or in the pipeline, which will increase contingent liabilities.
Medium-term growth projections depend on the pace of structural reforms and progress with EU accession. Efforts to sustain fiscal consolidation, mitigate fiscal risks from contingent liabilities, and accelerate energy sector reform are needed to safeguard macroeconomic sustainability. Improving the business climate and the rule of law remain priorities for EU accession and such efforts should be complemented by investments in infrastructure and human capital. That would reap the benefits of EU accession and ensure poverty reduction and shared prosperity. Given Albania’s limited resources, investments will need to be prioritized.
Albania is vulnerable to a slowdown in Europe, particularly in its neighboring main trading partners. A lack of growth in these countries could mean lower Albanian exports, remittances, and FDI. The expected tightening of monetary policy in advanced economies would also raise financing costs given the country’s high public debt, which is increasingly being refinanced through foreign sources. A slower-than-expected pace of reforms would also affect economic and social prospects.
Labor market trends
The Western Balkans Labor Market Trends 2019 report, issued on March 19 by the World Bank and the Vienna Institute for International Economic Studies, claim that labor market performance in the Western Balkans continued to improve, albeit at a slower pace than the previous year and despite stronger economic growth in the region. About 68,000 new jobs were generated between the second quarter of 2017 and the second quarter of 2018, compared to 231,000 a year earlier. In contrast, GDP growth in the region increased from 2.5 percent in 2017 to 3.9 percent in 2018.
Albania and Montenegro reported the strongest job growth in the region, with 3.3 percent each, followed by North Macedonia with a 2.1 percent increase. The majority of new jobs were created in industry and services. Women continued to be underrepresented in Western Balkan labor markets, but more than half of the employment increase benefited them. On average, regional labor markets recorded improvements in activity rates (up 0.5 percentage points to 62.8 percent) and employment rates (up 1 percentage point to 52.9 percent), but they remained far below European standards.
Unemployment reached historic lows in most Western Balkan countries, falling from 16.2 percent to 15.3 percent over the last year. Country rates ranged from around 12 percent in Serbia and Albania to 29 percent in Kosovo. The region also experienced a substantial decrease in long-term unemployment, from a peak of 1.5 million people in 2011 to 776,000 people in the second quarter of 2018. Still, unemployment remained a significant challenge in the Western Balkans, where levels were two to three times higher than in EU peer countries.
The report notes that informal employment, one of the major challenges of the Western Balkan labor markets, is still rising in Albania and North Macedonia, but dropping in Serbia. Young men, elderly women, and low-educated workers were most likely to hold informal jobs in 2018.
“Improvements in labor market performance are encouraging, but the decelerating trend raises some concerns. We still need a stronger private sector that generates adequate jobs and public policies that improve employability of the workforce to sustain labor market performance in the future,” said Linda Van Gelder, World Bank Director for the Western Balkans.
Despite their difficult labor market standing, the employment situation of youth continued to improve, with the youth unemployment rate falling by 3 percentage points to 34.6 percent. The majority were long-term unemployed, ranging from almost 70 percent in Bosnia and Herzegovina to 43 percent in Montenegro. On average, 50 percent of young people worked on a temporary contract basis, affecting 8 out of 10 young workers in Kosovo and Montenegro. Though declining, the share of youth (15-24 years of age) not in employment, education and training remained high at 22.3 percent. Below-average rates were reported in Montenegro and Serbia (around 17 percent), compared with the other Western Balkan countries (ranging between 24 and 26 percent).Wages and labor costs were significantly lower in the Western Balkans, compared to the EU, and there has been no clear convergence in recent years.
“In addition to the positive though fading momentum in employment developments, the recent trends in productivity and wage growth are worrying and need to be tackled by policy makers to assist both convergence and employment,” concludes Robert Stehrer, Scientific Director of the Vienna Institute for International Economic Studies.
The report finds that the taxation of labor income in the Western Balkans is comparatively high for low wage earners and workers with dependents, given the region’s low progressivity and infrequent use of family allowance in income tax regimes. Low-wage earners are at a particular disadvantage in the formal labor market in terms of their net take home pay and the relative high cost of hiring them compared with medium- or high-wage earners.
These disadvantages act as additional disincentives to work in formal jobs and for firms to create formal jobs, especially for low-educated, and other low-paid workers. A broad reform of the overall labor taxation system and social insurance might serve as the most promising avenue for the revitalization of Western Balkan labor markets.
