Higher But Fragile Growth

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Growth in the Western Balkans has strengthened to an estimated 3.5%.

In most of the region, growth projections for 2018 have been revised upward. Kosovo and Albania are expected to grow at 4% this year. At 3.8%, Montenegro’s growth is projected to be 1 percentage point higher, although still lower than last year. Growth in Bosnia and Herzegovina continues to be stable at an estimated 3.2%. Serbia’s economy has rebounded to 3.5% growth after last year’s weather-related slowdown. Macedonia’s growth also rebounded to 2.5%, as investor confidence was restored.

Growth was stimulated by higher public investment and consumption.

Driven by tax reforms and faster growth, higher tax revenues created fiscal space, which some countries rushed to use for current spending and capital investment. Greater public investment is a welcome sign, but to be successful it must be supported by more efficient and effective public spending. The surge in untargeted social spending and public wages has had an immediate effect on growth rates in several countries through faster growth in consumption and household credit. But such effects are temporary and costly to sustain: in the longer term they heighten fiscal vulnerability.

Over 90,000 jobs were created in the first half of 2018, with new employment mostly in industry and services.

But the overall labor market response to growth was slower than it could have been, reflecting the temporary nature of consumption-led stimuli as well as a rise in labor inactivity. In some countries, inactivity and emigration rather than new job creation explain the fall in unemployment.

Countries with higher growth rates boosted them mostly by investment and exports.

Higher private investment led to higher economic growth. But to sustain growth, more investment is needed in tradable sectors. With competition between emerging markets fierce, investors will be attracted by political stability, a business-friendly regulatory environment, quality infrastructure, and a skilled labor force. Since credit is driven mostly by household borrowing, a more diversified and growth friendly financial sector would also help to attract domestic and foreign investors.  

Higher exports are also necessary for more secure long-term growth.

External imbalances have been high but mostly stable. Bosnia and Herzegovina, Macedonia, and Serbia have all seen their exports grow fast. But growing consumption and large infrastructure projects have pushed up imports. Sustainably higher exports will help maintain macroeconomic stability, contribute to growth, and reduce poverty. Support could also come from regional integration. The Multi- Annual Action Plan for building a regional economic area is a step in the right direction.

The risks clouding a positive growth outlook are both external and internal.

A possible tightening of the financing conditions in international capital markets is a downside risk, especially in countries that have external and fiscal imbalances. With domestic sovereign bond markets often underdeveloped, Western Balkan countries are exposed to rises in global interest rates. Robust growth in the region also depends heavily on domestic and regional political stability, which define the speed of structural reforms. Mitigating these external and internal risks requires both a firm commitment to fiscal consolidation and acceleration of structural reforms.