All at once, Western Balkan countries are experiencing a set of financial shocks. The region’s economy was just starting to recover from the COVID-19 brought recession when it was hit by the aftermath of the Ukraine war, a resurgence of inflation, and an urgent energy transition. Navigating these crises is dangerous and will necessitate deliberate decisions.
All six of the Western Balkan regions—Bosnia, Albania, Herzegovina, Kosovo, North Macedonia, Serbia, and Montenegro, —saw 7.4% annual growth in 2021 as the economies recovered from the 2020 recession. Indeed, the power of recovery outperformed expectations, owing to a mixture of high consumer demand, relaxed restrictions on travel in spite of low vaccination and high infection rate, a rebound of investment, and the surge of exports—all backed by persistent fiscal support. A return to economic growth resulted in job creation, which helped in reducing poverty throughout these regions.
Tax revenues increased as the economy recovered in 2021, reducing public debt and budget deficits. A year of economic expansion, however, is simply insufficient for a country to rebuild its debt and fiscal buffers in preparation for the next massive shock. Government debt dropped to 57% of GDP in 2021, which is about 4% lower than its peak in 2020 but still better than the pre-COVID level of 50 per cent in 2019. Because of this, governments in the Western Balkans will have little leeway in 2022.
Even before Ukraine and Russia went to war, economic expansion in the Western Balkans was slowing to pre-crisis levels. Inflation was rising as worldwide supply fell short and there was an increase in demand which drove commodity prices higher every day. The Ukrainian conflict, which is driving up inflation, exacerbates the above two trends. It also erodes consumer and business trust, disrupt tourism and trade, and severely disrupts energy and food supply chains. This was especially true for Montenegro and Serbia, which are heavily reliant on trade with Ukraine and Russia.
There will be difficulties ahead.
The Western Balkans have an especially bleak future. COVID-19 is still operational, and the energy damage wrought by Ukraine’s war has exposed risk that is associated with the region’s continued dependence on fossil fuel. While most epidemiological controls were raised, and demand drove up investment and consumption, the war derailed that strategy. The real output will grow at 3.1% in 2022, 1% point lower than in the past, according to our current baseline scenario. Furthermore, as the dispute drags on into the summer of 2022, sanctions tighten and EU growth slows even more additional growth downgrades and higher inflation forecasts are likely
Not only is the region’s growth slowing, but rising energy and food prices imply that the poorest families, which dedicated more than 60% of their budget allocations to energy and food, are facing especially high inflation. They frequently lack the necessary coping skills to absorb higher living costs.
Policy exchange must be made in an uncertain world.
The Western Balkan economies fared relatively well during the COVID shock, rebounding way quicker than expected, leveraging fiscal and monetary policy to assist vulnerable firms and households. However, reserves have been drained and addressing immediate needs while also focusing on the policy changes required to support greener, equitable, and more sustainable growth in the future presents a significant challenge.
Governments will also have to be fiscally responsible in order to preserve the poorest families, which spend the majority of their income on energy and food. Policy responses to immediate needs should be limited in time, allowing governments to return to buffer-building as pressures subside. Moreover, in an era of limited resources, governments must increase attempts to improve tax administration, enhance social assistance to protect the poor, reallocate resources to energy-efficient investments, and encourage private investment in renewable energy.
The governments must also remember reforms that have gone mostly unnoticed since 2020 but are critical to increasing long-term growth prospects. Structured reforms to enhance human capital, increase labour-force participation (particularly among women and young people), and increase in competition would help boost growth, which had already been slowing before this crisis. Furthermore, attracting greener and elevated foreign investment will indeed necessitate greater efforts to simplify business regulations, as well as increase digitization and connectivity.