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Macroeconomic stability despite external shocks

Despite their many vulnerabilities, including a high dependency on the European market and a complex political environment, the economies of the Western Balkans have held up remarkably well against two external shocks since 2022: the war in Ukraine and Europe’s economic slowdown. The foreign exchange risk has been contained thanks to the support of foreign direct investment and external financing. Buoyant domestic demand has helped to offset the effects of the slowdown in Europe on exports. Inflationary pressures, which were still substantial in 2023, are expected to ease this year. In Croatia, macroeconomic risks will be reduced significantly thanks to the eurozone accession. However, its high dependency on tourism activity is still a factor of vulnerability. While Serbia’s admission to the EU is still being hindered by predominantly political factors, its economic performance has been strong, both in terms of external accounts and public finances.

Limited impact of the war in Ukraine


The gradual severing of ties between Europe and Russia has not led to any major economic difficulties in the Western Balkans, in particular thanks to a limited dependency on gas imports (Slovenia and Montenegro) and diversified energy-supply sources (development of LNG terminals in Croatia and low dependency on Russian gas in North Macedonia). In theory, the country most exposed to the supply risk is still Serbia, due to its dependency on Russian gas imports, which account for 90% of its gas imports. In June 2022, the Serbian government secured its imports on favourable terms by renewing its supply contract with Russia for three years.

Beyond energy issues, the war in Ukraine has severely disrupted commodity markets and capital flows. Part of the Balkans is particularly sensitive to any shortfall in its balance of payments, given that most local currencies are pegged to the euro (Croatia and Slovenia are members of the euro area) and public debt and bank balance sheets are being significantly euroised. Even though the link with the single currency can take various forms (from a managed exchange rate policy in Serbia to a de facto euroisation of the economy in Kosovo), in order to ensure that the foreign exchange regime remains credible, countries must hold sufficient foreign-currency liquidity to be able to cope with any deterioration in the balance of payments. Unsurprisingly, the current account deficit increased in 2022, rising on average from 5.5% to 8.2% of GDP. While the Western Balkan countries came into the crisis with satisfactory levels of foreign-currency liquidity, their financing needs have been covered by buoyant foreign direct investment (as is the case in Serbia, Montenegro and North Macedonia), as well as by the support of multilateral lenders (Serbia and North Macedonia).

Impact of Europe’s economic slowdown offset by domestic demand


The vulnerability to Europe’s economy can take various forms, as the European Union is the largest export market for goods, the main source of tourists and the main destination for expatriates who contribute significantly to local activity through remittances. In 2023, the economic slowdown in Europe (0.5% in the euro area and -0.1% in Germany) had contrasting effects on activity. On average, exports of goods and services slowed sharply during the first three quarters.

However, household consumption remained sustained, thanks in particular to real wage growth in Slovenia, Serbia and Croatia against a backdrop of receding inflationary pressures. For all of the countries, inflation is expected to fall from 12% on average in 2022 to 4.2% in 2024, according to European Commission forecasts. Investment was the other main growth driver in 2023, buoyed in particular by foreign direct investment and EU funding.

According to European Commission forecasts, growth should reach 2.5% on average across the entire area. In Slovenia, activity is expected to be slower (+1.3% expected), due to the floods that hit the country hard during summer 2023. About 80% of the country’s municipalities were affected by this climatic event and the direct damage is estimated at around 5% of GDP, according to the European Commission. In 2024, average growth is expected to barely accelerate at all, rising to just 2.6% against a backdrop of a fragile economic recovery in the euro area (+1.6% expected).

Croatia: eurozone accession

2023 saw Croatia join the euro area. By removing the foreign exchange risk, Croatia’s eurozone membership significantly reduces specific risks associated with the high share of government debt denominated in foreign currencies (70% of the total, mostly in euros) and the euroisation of around 70% of bank balance sheets.

In addition, both adopting the euro and joining the Schengen Area is expected to benefit the tourism accommodation sector. Tourism is a key sector of the Croatian economy, as it contributes to around a quarter of its GDP (compared to less than 10% on average in the European Union). In 2023, annual tourist numbers were almost back at their pre-pandemic levels. The size of the tourism sector within the economy reduces some risks, in particular, the risk of energy-price volatility on activity, but increases others, including the risk of dependency on the European economy. In the longer term, the rising temperatures and drought risk expected to affect the entire Mediterranean region will adversely impact tourist numbers and the availability of some resources, such as water.

Public finances are sound, and with accounts being kept practically balanced in 2022 and 2023, this will help to reduce the government debt ratio, which is expected to be below 60% of GDP in 2024.
Significant financial support is being provided by the European Union and this should help the country to gradually catch up with the European standard. In 2022, Croatia’s GDP per capita was 73% of the European Union average (60% in 2013). By 2030, it is estimated that Croatia (which has a high capacity to absorb European funding) could receive European support funds equivalent to a quarter of its current GDP.

Serbia: sound economic fundamentals


Over the past two years, Serbia has been evolving in a complex political environment. This is because, on top of the recurring regional tensions, there have also been the consequences of its close partnership with Russia, which have damaged its relations with the European Union. These factors may hinder the country’s integration into the European Union. However, from an economic perspective, its fundamentals are still sound and will help it to cope with any external shocks.

Given the significant euroisation of bank balance sheets and government debt, the Serbian economy’s ability to generate sufficient foreign currency is a key factor in the country’s macroeconomic stability. In practice, the foreign exchange policy focuses on keeping the dinar stable against the euro and has resulted in interventions in the foreign exchange market by the National Bank of Serbia. Due to a recurring and rather high current account deficit (5.4% of GDP on average over the 2018-22 period) and a large external debt amortisation (10.4% of GDP on average over the 2018-22 period), the country has a substantial financing need. This is being covered by net foreign direct investment (which has covered an average of 140% of the current account deficit since 2015) and by external debt flows. Despite a much higher risk premium than before the war in Ukraine broke out (193 bps currently compared to less than 100 bps before March 2022), Serbia is still issuing sovereign bonds on international markets (USD 1.75 bn issued in 2023). In addition, the Serbian government’s compliance with the IMF’s requirements has resulted in financing tranches under a Stand-By Arrangement worth a total of EUR 2.4 billion (3.5% of GDP) being regularly disbursed. The National Bank of Serbia has enough foreign exchange reserves to limit the foreign exchange volatility and fulfil the IMF’s prudential criteria.

Public accounts have improved significantly since 2016, particularly under the IMF’s supervision. While IMF support is not crucial from a financing perspective, it does help to anchor the country’s macroeconomic policy. After the significant deterioration in the fiscal balance as a result of the pandemic (-8.0% of GDP in 2020), followed by the need to increase wages and social spending against a backdrop of persistent inflation (+7.6% y/y in December 2023), the budget deficit is expected to gradually fall thanks to spending control (2.2% of GDP, according to the European Commission forecast). Public debt is at a moderate level (56% of GDP in 2022), and the government has liquid deposits equivalent to around 5% of GDP, according to IMF estimates. Debt interest payment accounts for around 4.5% of budget revenues (2023 estimate), and allows for some fiscal policy flexibility.

Article completed on 5 February 2024.

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