Western Balkan countries are simultaneously facing a series of economic shocks. The region’s economy was just beginning to recover from the COVID-19-induced recession, but it now also faces fallout from the war in Ukraine, a resurgence of inflation and an urgent energy transition . Managing these crises carries risks and will require careful choices.
The six Western Balkan economies – Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia – experienced a strong economic recovery with growth of 7.4% in 2021, as the region recovered from the recession of 2020. In fact, the strength recovery exceeded forecasts due to a combination of pent-up consumer demand, an easing of travel restrictions despite high infection rates and low vaccination, as well as a rebound in investment and a strong increase in exports, all supported by continued budgetary support. The return to economic growth has led to job creation, helping to reduce poverty in the region.
Tax revenues also rebounded in 2021 as growth resumed, reducing budget deficits and public debt. However, one year of growth is simply not enough for a country to rebuild its fiscal reserves and debt in anticipation of the next shock, even 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 than the 50% in pre-COVID-19 2019. As a result, Western Balkan governments approached 2022 with some room for maneuver.
Even before the outbreak of war between Russia and Ukraine, economic growth in the Western Balkans was already slowing to pre-crisis rates, and similarly, inflation was already rising as supply constraints and pent-up demand across the world were driving up commodity prices. The war in Ukraine is exacerbating both trends and also pushing inflation sharply higher. It also undermines business and consumer confidence, impacts trade and tourism, and causes serious disruption to 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 testing time
The Western Balkans now face a particularly uncertain outlook. In addition to the outbreak of war, COVID-19 has not gone away, and the energy disruptions caused by the war in Ukraine have exposed vulnerabilities linked to the region’s heavy reliance on fossil fuels. While we expected a continued strong rebound in 2022, with most epidemiological measures lifted and with pent-up demand driving consumption and investment growth, the war disrupted this trajectory. In our current reference scenario, we forecast real output growth of 3.1% in 2022 – a downward revision of almost a percentage point – and below the historical growth rate. Furthermore, further downward revisions to growth and higher inflation forecasts are likely as the conflict extends into summer 2022, sanctions intensify and inflation growth EU is still slowing down (graph 1).
Not only is the region facing slowing growth, but rising food and energy prices mean that the poorest households who spend more than 60 percent of their budget on food and The energy sector is experiencing a particularly high rate of inflation (Figure 2). They often lack the coping mechanisms necessary to absorb a higher cost of living.
Political compromises in a context of uncertainty
Western Balkan economies weathered the COVID-19 shock relatively well, as they bounced back faster and stronger than expected, using fiscal policy to support vulnerable households and businesses. However, resources have been exhausted 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 frugal, prudently using their limited budgetary resources to protect poorer households who spend a larger share of their income on food and energy. Policy measures to address current and urgent needs should be time-limited so that governments can return to replenishing reserves as pressures dissipate. Furthermore, in a resource-constrained environment, now is the time for governments to step up efforts to improve tax compliance, strengthen social assistance systems to protect the energy poor, and reallocate resources towards investments in energy efficiency, as well as enabling private investment in renewable energy. energy.
Finally, governments must not lose sight of the reforms neglected since 2020, which are essential to strengthening long-term potential growth. Structural reforms to improve human capital, support labor market participation (especially for women and young people) and strengthen competition would help boost potential growth which was already slowing before the current crisis. Furthermore, to attract greener and higher value-added foreign investments, greater efforts should be made to streamline business regulations and boost connectivity and digitalization.