South East Europe Regular Economic Report (See Rer) No. 2

Abstract

After they achieved 2.2 percent growth in 2011, early indications are that the economies of the six countries in South East Europe (the SEE6: Albania, Bosnia and Herzegovina (BIH), Kosovo, FYR Macedonia, Montenegro, and Serbia) are slowing drastically and can expect just 1.1 percent growth in 2012. Economic conditions in the Eurozone are holding back economic activity and depressing government revenues in SEE6 countries. With both public debt and financing pressures high, most countries in the region need to embark on major fiscal consolidation programs if they are to reverse their adverse debt dynamics and avoid financing problems down the road. The good news is that in general the SEE6 financial sectors are still relatively well placed, despite elevated risks and vulnerability to adverse shocks, especially the possibility of contagion if the Greek crisis should intensify. In SEE6, levels of non-performing loans (NPL), though high, seem at least to be stabilizing, capital buffers and provisioning look solid, and liquidity is adequate in most of the region. But given the significant risks in the Eurozone associated with the Greek crisis, it cannot be overemphasized that the authorities must continue to demand that banks build up their buffers to make the sector more resilient.The bad news is social: SEE6 countries have the highest unemployment and poverty rates in Europe. Moreover, what growth there was during the nascent recovery in 2010-11 was largely jobless. At about 23 percent, the average unemployment rate in SEE6 is more than twice the Western Europe average, and is highly concentrated among youth and long-term unemployed, with devastating impact on human capital. Pre-crisis poverty reduction gains are being reversed, and after large shocks and depleted household buffers and savings, the middle class has become more vulnerable. With growth prospects much more moderate than before the crisis and with social pressures high, it is urgent that SEE6 country governments adopt a more ambitious structural reform agenda for growth and jobs. Yet even with the difficult short-term situation, SEE6 countries now have historic opportunity to board the European “convergence train” and over the long term reduce their per capita income gap with developed European Union countries. All earlier entrants were able to “catch up quickly.” In principle, the same “convergence train” is now pulling into the EU candidate countries in SEE6; but these gains are not automatic, they will materialize only if country policies and reforms facilitate them. The long-term SEE6 structural reform agenda must leverage greater trade and financial integration and reform labor markets and the public sector.