As Western Balkan economies sought to recover from the shock of COVID-19, the region now faces a new combination of challenges. The war in Ukraine and the resulting sharp rise in energy prices, as well as slowing global growth and tightening global finances, are weighing heavily on the situation. on economic performance in the six economies— Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia — despite a good start in the first six months of 2022.
In fact, during the first half of 2022, employment levels reached historic highs in several countries. The region’s employment rate now averages 46 percent, an increase of 3 percentage points from last year. All sectors contributed to the labor market recovery, with services (including tourism) playing a particularly important role. As a result, labor shortage has become a major concern promoted by companies throughout the region.
The unemployment rate in the Western Balkans also fell to a historic low of 13.5% by mid-2022, allowing around 151,000 people to move out of unemployment and into employment. Encouragingly, the widespread recovery in the labor market has also benefited vulnerable groups and lifted an equivalent number of people out of poverty. Youth unemployment also reached a record high of 27.1 percent, while the female labor force participation rate increased to 53 percent by mid-2022 (up 2.6 percentage points).
The region is heading for a new storm
However, the region is now facing a series of negative shocks. The six countries are close to the eye of the storm in terms of the global energy crisis and Russia’s invasion of Ukraine, but without the protective umbrella that advanced economies and European Union countries are able to provide. offer to their vulnerable populations. Rising energy and food prices have pushed inflation to levels not seen in decades, eroding purchasing power and business confidence. High inflation affects the least well-off relatively more than other income groups, which could erase recent progress in reducing poverty.
The region’s export boom has begun to slow, just as import costs have risen sharply due to rising commodity prices, sharply widening current account deficits and putting pressure on currencies and markets. foreign exchange reserves. More recent data also suggests that the labor market is starting to cool, with employment growth slowing amid high inflation and increased uncertainty. And the monetary tightening needed to control inflation is driving up financing costs and weakening demand, including among the region’s main trading partners.
This heady combination of supply and demand shocks is weighing heavily on the region’s outlook, keeping inflation high and weakening consumer and investor confidence. Economic activity is slowing sharply in advanced economies, particularly in the Eurozone, which is a key source of demand for Western Balkan goods and services, as well as a source of investment and remittances. As a result, growth in the Western Balkan countries has been further revised downward for 2023 (Chart 1).
Looking beyond crises
Governments are facing severe budgetary pressures due to a combination of energy aid needs and higher financing costs. This comes at a time when fiscal space has already been exhausted due to COVID-related policy support and financing conditions have tightened. Yields on Eurobonds issued by Western Balkan countries widened significantly in 2022, with some of them reaching almost 10%. Fiscal risks will need to be closely monitored as energy production and distribution companies struggle to finance their operations and, in several countries, cannot fully pass on rising costs to end users. Budget deficits are expected to widen and public debt to increase.
In the short term, at a time when public sector resources are scarce and fiscal space is limited, governments can prioritize policy support for vulnerable people, ensuring that measures are targeted and limited in scope. time in order to minimize budgetary risks. . But at the same time, no-regret reforms, such as reforms to the business environment, governance and competition policy, would boost growth in the medium term with limited fiscal cost.
Given the significant obstacles to long-term growth prospects, it will be essential for Western Balkan economies to advance structural reforms and accelerate economic transformation. . Convergence with their European peers is only possible for the Western Balkans if the potential growth rate is increased.
In the medium term, it would be appropriate to prioritize reforms with limited fiscal cost that would serve to accelerate potential growth and convergence (Figure 2). This would include measures to:
- raise governance standards, including digitalization,
- increase the level of competition in the market,
- remove barriers to entry for businesses,
- increase the retention and reinvestment of foreign investors to boost factor productivity,
- improve skills, and
- reduce barriers to women’s participation in the labor market.