WESTERN BALKANS regular economic report No. 25 | Spring 2024 Invigorating Growth Western Balkans Regular Economic Report No.25 | Spring 2024 Invigorating Growth © 2024 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. The cover image depicts green coverage in urban areas in the Western Balkans region. The cutoff date for the data used in this report was March 25, 2024. INVIGORATING GROWTH Acknowledgements This Regular Economic Report (RER) covers economic developments, prospects, and economic policies in the Western Balkans region: Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia. The report is produced twice a year by a team led by Natasha Rovo, Richard Record, and Isolina Rossi (Task Team Leaders). This issue’s core team included World Bank staff working on the Western Balkan countries (with additional contributions to specific sections): Natasha Rovo, Richard Record (Growth section), Sanja Madžarević-Šujster, Joana Madjoska, Tim Pionteck (Labor section), Alexandru Cojocaru, Carlos Gustavo Ospino Hernandez, Anna Fruttero, Zurab Sajaia (Poverty section), Milan Lakićević, Besart Myderrizi (Fiscal section), Hilda Shijaku, Isolina Rossi (Monetary section), Alper Oguz, Jane Hwang (Financial sector section), Sandra Hlivnjak, Tihomir Stučka (External section), Christos Kostopoulos, Lazar Šestović, Marie Albert (Outlook section), Megha Mukim, Tianyu Zhang, Serene Vaid, and Nicholas Jones (Spotlight). The team is thankful for comments received from the peer reviewers Bledi Celiku, Miguel Angel Saldarriaga Noel, Ellen Hamilton, and Mark Roberts. Research assistance was provided by Suzana Jukić. Peter Milne provided assistance in editing, and Budy Wirasmo assistance in designing. The cover image was created by Voilà. The dissemination of the report and external and media relations are managed by an External Communications team comprised of Filip Kochan, Sanja Tanić, Lundrim Aliu, Anita Božinovska, Ana Gjokutaj, Jasmina Hadžić, Gordana Filipovic, and Mirjana Popović. The team is grateful to Xiaoqing Yu (Regional Director for the Western Balkans); Asad Alam (Regional Director, Equitable Growth, Finance and Institutions); Jasmin Chakeri (Practice Manager, Macroeconomics, Trade, and Investment Global Practice); Christoph Pusch (Practice Manager, Urban, Resilience and Land Global Practice); and the Western Balkans Country Management team for their guidance in preparation of this report. The team is also thankful for comments on earlier drafts of this report received also from Ministries of Finance and Central Banks in Western Balkans countries. This Western Balkans RER and previous issues may be found at: www.worldbank.org/eca/wbrer/. iii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Contents Acknowledgementsiii Abbreviationsviii Invigorating Growth 1. Overview 1 2. Growth returned to its pre-pandemic average, reflecting regional developments and countries’ characteristics 7 3. Employment growth slowed in 2023, as economic growth continued to slow 10 4. The pace of poverty reduction has slowed and vulnerabilities persist 18 5. Fiscal consolidation continued, amid rising pressures from current expenditure 21 6. Price increases have eased substantially, but inflationary pressures remain elevated 26 7. The financial system has maintained resilience while navigating sustained risks 30 8. The external position is improving on the back of lower import prices and strong net services exports 36 9. The outlook improved, but growth remains too low for faster convergence with the EU 40 10. Heatmap: Western Balkans Indicators 47 11. Spotlight: Greening Cities 48 iv Contents INVIGORATING GROWTH Figures Figure 2.1. Growth in 2023 is estimated at 2.6 percent, below the pre-pandemic average 8 Figure 2.2. Real GDP comfortably surpassed 2019 levels 8 Figure 2.3. Consumption remains the main growth driver in most WB6 countries 8 Figure 2.4. Given the medium to high trade openness, trade is key to growth for the WB6 8 Figure 2.5. Construction has picked up in 2023, for Albania and Serbia 9 Figure 3.1. Employment growth was modest in 2023 10 In all WB6 countries except North Macedonia, employment levels are above Figure 3.2.  their pre-pandemic levels 10 Figure 3.3. Construction and services gained strength, while agriculture continued to decline 11 Figure 3.4. The employment rate increased compared to 2022 11 Figure 3.5. Unemployment rate declined in all WB6 countries in 2023 11 Figure 3.6. Youth unemployment rate was more than double the overall unemployment rate 11 Figure 3.7. More people joined the WB6 labor force 11 Figure 3.8. Female to male labor participation gap narrowed to 18 percentage points 11 Figure 3.9. Average real wage and productivity growth, 2015–2023 13 Figure 3.10. Change in total hours worked and contributions 15 Figure 3.11. Change in total hours worked and contributions: disaggregated by gender 16 Figure 4.1. Poverty is expected to decline at a slower rate in the WB6 18 Figure 4.2. Many households are barely making ends meet… 19 Figure 4.3. …and would not be able to cope with a sudden loss of main income source 19 Figure 5.1. Fiscal consolidation continued to gain ground across the region… 21  against positive revenue performance, and contained expenditures in Serbia Figure 5.2. … and Albania 21 Figure 5.3. Capital spending was subdued… 22  while all WB6 countries turned to higher spending on public wages and social Figure 5.4. … benefits22 Figure 5.5. Total PPG debt as a share of GDP declined to its lowest in a decade… 24 Figure 5.6. …thanks in part to a decline in external PPG debt 24 Figure 6.1. WB6 consumer inflation was on a downward trend in 2023… 27 Figure 6.2. …reflecting heterogeneity among countries 27  B6 core inflation has remained persistently high, although trending Figure 6.3. W downwards through 2023 27 Figure 6.4. The persistence of core inflation is observed in all WB6 countries 27 Central banks tightened monetary policy in response to persistent inflation Figure 6.5.  expectations27 Amid currency appreciation pressures, central banks allowed for different degree Figure 6.6.  of exchange rate flexibility 27 Figure 6.7. Inflation slowed across the globe in 2023… 28 Figure 6.8. …but remains above target in many inflation-targeting economies 28 Contents v WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Figure 7.1. Sluggish credit growth dominated H2 2023, particularly in Albania and Serbia 30 Weakening corporate loan growth dipped to 1 percent in October before Figure 7.2.  bottoming out 30 Figure 7.3. Asset quality improvements slowed down, with NPL ratios almost flat in 2023 32 Figure 7.4. Banks’ capital buffers strengthened 32 Figure 8.1. The regional current account deficit keeps improving… 36 …with North Macedonia and Serbia accounting for largest share of the external Figure 8.2.  adjustment36 The merchandise trade deficit has returned to the long-term average, after the Figure 8.3.  deterioration in 2020… 37 …and remittances remain robust, while net services exports maintain record Figure 8.4.  highs reached in 2022 37 At the regional level, FDI inflows fully finance the CAD, but country differences Figure 8.5.  are significant 38 Figure 8.6. Total external debt continued its decline in 2023, reaching 71.3 percent of GDP 38 With currently projected growth rates, the WB6 region is expected to return on Figure 9.1.  its pre-pandemic trend in 2024 41 Measured in PPP terms, GDP per capita in the Western Balkans remains at Figure 9.2.  almost 40 percent of the EU average 41 Figure 9.3. The global economy is expected to face the weakest half-decade growth since 1995 41 Figure 9.4. Global economic developments 43 Figure 9.5. Coordinated action to reduce border waiting times in the WB6 would boost income45 Neighboring EU countries also benefit from faster trade in the WB6, especially Figure 9.6.  if it is coupled with investments in connectivity infrastructure 45 Figure 11.1. Capital cities account for a large share of national GDP, population, labor force, jobs, and active enterprises 48 Figure 11.2. Annual urban population growth of the Western Balkan countries, 2000–2022 49 Figure 11.3. PM2.5 concentrations, in cities and by region 53 Figure 11.4. Average fossil CO₂ emissions, by country 53 Figure 11.5. Change in methane emissions 54 Figure 11.6. Relationship between city compactness and CO₂ emissions across cities, residential and transportation sectors 55 Figure 11.7. Determinants of air pollution (PM2.5) for cities in the region, residential and transportation sectors 55 Figure 11.8. Percentage of green cover in WB6 urban clusters 56 Figure 11.9. Evolution of the frequency and intensity of extreme heat events for cities in Western Balkans, 1958–69 to 2011–20 57 Figure 11.10. Change in average heat wave magnitude index daily (1990–2040) 57 Figure 11.11. Average surface and air temperature patterns across urban to rural environments 58 Figure 11.12. Contained urban expansion areas for Pristina until 2040 60 Figure 11.13.  Relationship between urban temperature and percentage of impervious surface (left) and tree canopy cover (right) 62 vi Contents INVIGORATING GROWTH Boxes Box 3.1. Labor markets in the Western Balkans: navigating demographic shifts and emigration 14 During 2023, inflation started to slow across the globe, raising hopes of a further Box 6.1.  easing of inflationary pressures into 2024 28 Box 7.1. The insurance sector development in the Western Balkans, and Solvency II 34 This year will continue to be challenging, before brighter horizons appear in Box 9.1.  2025–2026  42 The EU’s new Growth Plan for the Western Balkans offers the promise of faster Box 9.2.  convergence with EU living standards, if opportunities are grasped 44 Box 11.1. Defining cities and greenness 50 Box 11.2. Extreme heat will worsen existing inequalities 58 Box 11.3. Green urban development in Serbia 64 Box 11.4. EBRD Green Cities Program in Bosnia and Herzegovina 64 Tables Table 1.1. Western Balkans Outlook, 2020–26 6 Table 5.1. Yields on Western Balkans countries’ outstanding Eurobonds 25 Table 5.2. Credit ratings of the Western Balkan countries 25 Table 9.1. Real GDP growth 40 Western Balkans Indicator Heatmap 47 Key categories of action to cool the physical spaces and prevent harmful heat Table 11.1.  exposure in cities 63 Policy actions for urban greening in the WB6 countries and main responsible Table 11.2.  institutions67 Contents vii WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Abbreviations AE Advanced Economies OECD Organisation for Economic Co- operation and Development CAD Current Account Deficit PISA Programme for International CCDR Country Climate and Student Assessment Development Report PM2.5 Particulate matter 2.5 micrometers CESEE Central, Eastern and Southeastern or less in diameter Europe PM10 Particulate matter 10 micrometers CH4 Methane or less in diameter CO2 Carbon Dioxide PMI Purchasing Managers Index CPI Consumer Price Index ppb parts per billion DPL Development Policy Loan PPG Public and Publicly Guaranteed EBRD European Bank for Reconstruction PPP Purchasing Power Parity and Development Q1 First Quarter EC European Commission Q2 Second Quarter ECA Europe and Central Asia Q3 Third Quarter EIB European Investment Bank Q4 Fourth Quarter EMDEs Emerging Markets and Developing Economies RCP Representative Concentration Pathway EU European Union rhs right-hand scale FBiH Federation of Bosnia and Herzegovina RS Republic of Srpska FDI Foreign Direct Investment SEPA Single Euro Payment Area GDP Gross Domestic Product SILC Survey of Income and Living Conditions GHG Greenhouse Gas SMEs Small and Medium Enterprises H1 First Half SOEs State-Owned Enterprises H2 Second Half TIPS TARGET Instant Payment HBS Household Budget Survey Settlement HEWS Heat Early Warning Systems UN United Nations ICT Information and Communications UNDP United Nations Development Technology Programme IFRS International Financial Reporting US United States Standard WDI World Development Indicators IMF International Monetary Fund WHO World Health Organization LCU Local Currency Unit yoy year-on-year LFS Labor Force Survey SBA Stand-By Arrangement lhs left-hand scale SEPA Single European Payments Area NPLs Non-Performing Loans viii Abbreviations INVIGORATING GROWTH SILC Survey of Income and Living Conditions SMEs Small and Medium Enterprises SOE State-Owned Enterprise SWG Standing Working Group TARGET Trans-European Automated Real- time Gross settlement Express Transfer system TIPS TARGET Instant Payment Settlement UAA Utilised Agricultural Area UNWTO United Nations World Tourism Organization WDI World Development Indicators yoy year-on-year Western Balkan Country Abbreviations ALB Albania BiH Bosnia and Herzegovina KOS Kosovo MKD North Macedonia MNE Montenegro SRB Serbia WB6 Western Balkans 6 Note: All comparisons are year on year unless otherwise stated. Abbreviations ix Invigorating Growth INVIGORATING GROWTH 1. Overview Economic growth in the Western Balkans The regional labor market continued to slowed to 2.6 percent in 2023, from the perform well in 2023 but is beginning to show 3.4 percent reached in 2022, reflecting signs of cooling. The aggregate employment the impact of a weak European economy rate for the Western Balkans as a whole (15+) weighed down by sequential shocks. The reached a new historical high of 48.1 percent ongoing impact of Russia’s invasion of Ukraine in 2023. Unemployment declined across and the inflationary spike that it unleashed all countries, with the overall rate reaching has had an adverse impact on growth in the 10.9 percent in 2023. However, while youth European Union (EU), a key trading partner unemployment also declined to 25.5 percent, for the Western Balkans. The EU’s sizable it remains structurally high compared with growth slowdown in 2023, plummeting from the EU average of 13.8 percent during the 3.6 percent in 2022 to an estimated 0.6 percent same period. Encouragingly, the labor force in 2023, rippled across the region, impacting participation rate also improved over the course trade, investment and business confidence in of 2023, averaging 54 percent in 2023, with the Western Balkans (WB6). evidence that after two years of improvements, the female-to-male participation gap for the Growth performance surprised positively in region increased by 0.5 pp over 2023, to Serbia and Montenegro, while the other four 19.7 percent. Real wages increased in 2023, countries performed below expectations. reversing trends in 2022 during which inflation The post-pandemic recovery throughout outpaced wages. However, in all countries 2021 and 2022 displayed strong duality in except Kosovo, average wage growth was faster the performance of WB6 countries—with than productivity growth, suggesting that the the relatively more manufacturing-oriented primary drivers of higher pay were more due economies (Serbia, Bosnia and Herzegovina, to minimum wage reforms and labor shortages North Macedonia) most affected by the rather than improved firm-level dynamics. slowdown in the EU (especially in Germany), and the relatively more services-oriented Overall, the WB6 region has experienced economies (Albania, Montenegro, Kosovo) a rise in total hours worked driven by benefiting most from the robust demand for employment growth and labor force tourism and international travel. This duality expansion, especially driven by women was partially reconciled over the course of joining the labor force. From 2014 onward, 2023, due to a normalization in the pattern all WB6 countries have seen a rise in total of economic activity, as the sources of growth hours worked, although the pandemic did slow returned to trend. As of end-2023, levels of the rate at which total hours worked increased. real GDP in all WB6 countries comfortably Importantly, since 2014, all WB6 countries surpassed pre-pandemic levels. have enjoyed consistent positive growth in employment rates, a trend that has withstood the challenges of the pandemic. Women have contributed significantly, with their annual 1. Overview 1 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 increase in total hours worked outpacing that country where fiscal policy saw a significant of men across all WB6 countries. Furthermore, expansion. In most cases, fiscal performance women’s higher participation rates contributed was supported by higher direct taxation and to this trend in all WB6 countries, including grants receipts and, despite the decelerating in Kosovo where it was disproportionately inflationary impetus, all WB6 countries low. Recently, the WB6 countries have been experienced nominal revenue growth during the reforming their immigration policies to year. Current spending pressures, particularly meet growing labor demand, to counteract for public wages and social benefits but also the demographic decline and emigration of including interest payments, remained high workers to the EU. despite the overall contraction in expenditures in half of the WB6 countries. Poverty in the Western Balkans returned to its declining trend during 2023, but at a A robust fiscal performance and solid rate of slower pace than pre-pandemic. The overall GDP growth led to a fall in debt as a share pace of poverty reduction is forecast to have of GDP. Consequently, public and publicly slowed down from over 3 percentage points guaranteed (PPG) debt declined in most WB6 annually pre-pandemic to roughly 1 percentage countries, with the regional average PPG point annually between 2022 and 2025. This debt-to-GDP ratio falling from 50.4 in 2022 flattening of the poverty reduction trend is due to 47.3 percent in 2023. North Macedonia to decelerating growth in the region and to the stood out as the sole exception, experiencing sharp increases in the prices of food and energy a 3-pp increase in PPG debt as a share of during 2022–2023, which strained households’ GDP in 2023. Montenegro recorded the most purchasing power. The level of vulnerability substantial decline in its PPG debt-to-GDP to income shocks also remains high despite ratio, falling from 70.9 percent in 2022 to an progress on poverty reduction. New data show estimated 62.2 percent in 2023. While the cost that around half of all adults in the Western of external financing has declined from its peak Balkans live in households that report just in 2023, it remains elevated. After a hiatus, being able to make ends meet or having to dip economies reengaged with the markets in 2023 into savings or take on debt, and thus are not with Serbia, North Macedonia and Albania all able to save any portion of their income. issuing Eurobonds (followed by Montenegro in early 2024). All issuances incurred greater Fiscal consolidation gained ground in most costs compared with the preceding two years, Western Balkan countries over 2023. At although spreads with German bonds have 1.5 percent of GDP, the region’s estimated begun to narrow. average fiscal deficit for 2023 contracted faster than previously expected, dropping by After increasing to levels not seen in several 1.2 percentage points of GDP over the year, decades, inflation rates in the WB6 fell and falling to half of the level recorded in significantly during 2023. The primary 2021. Consolidation was particularly strong driver of reduced inflation was decelerating in Montenegro and Albania, with Montenegro international commodity prices, particularly ending the year running a fiscal surplus. In energy and food, which together account for contrast, Bosnia and Herzegovina was the only a high share of consumption baskets in the 2 1. Overview INVIGORATING GROWTH Western Balkans. Average inflation for the The WB6 countries witnessed a notable WB6 as a whole decreased progressively over improvement in their external position the course of the year from 14.3 percent in during 2023. The current account deficit January 2023 to 5.1 percent in December declined to a historic low of 4.9 percent of GDP 2023. However, there are notable differences in 2023, from 7.8 percent of GDP in 2022, in the pace of price deceleration, with inflation marking the most significant improvement in in December 2023 ranging from 2.2 percent the past two decades. The primary driver across in Bosnia and Herzegovina to 7.6 percent in the region was import compression, in both Serbia, with the other countries falling in volume and value terms, particularly for energy between. However, second round domestic imports, as the effects of the 2022 energy pressures from wages and production costs crisis abated. While Bosnia and Herzegovina remain elevated, as indicated by the persistently experienced a marginal uptick in the external high core inflation. deficit, all other countries in the region showed improvements in their external balances, with The financial sector in the Western Balkans the most significant improvements seen in continued to show resilience throughout North Macedonia (which recorded its second- 2023, despite slowing growth, inflationary ever current account surplus) and in Serbia. pressures and tighter financing conditions. Furthermore, remittances rose but more slowly Credit growth was slow in 2023, at below than regional GDP during the year. Therefore, 6 percent in the second half of 2023, amid despite growing by an estimated €230 million, tightening credit supply conditions. in GDP terms remittances decelerated to Improvements in the asset quality of banks 6.5 percent in 2023 from 7 percent of GDP the also decelerated during the year. The average year before. The current account deficit at the non-performing loans (NPLs) ratio improved WB6 regional level is entirely financed by net only marginally by 0.1 percentage points to foreign direct investment (FDI) inflows, which 3.8 percent, remaining broadly flat during amounted to 5.4 percent of GDP in 2023, 2023. Higher interest rates helped boost exceeding the external deficit by 0.5 percent bank lending margins and profitability. of GDP. Most countries in the region also Profitability, as measured by return on witnessed a build-up in foreign exchange assets, increased to 2.4 percent in September reserves during the course of 2023. 2023 from 1.7 percent a year before. As a result, capital buffers in the Western Balkan Growth projections for the medium term countries continued to strengthen, thanks have increased slightly, reflecting cautious to a combination of higher profitability and optimism that, having weathered a flurry low NPLs, while liquidity remained broadly of shocks over recent years, the Western stable. As of September 2023, the bank capital Balkans is beginning to see a return to adequacy ratio averaged 19.3 percent, far above trend economic performance. Regional GDP the regulatory minimum. growth for the WB6 is expected to increase to 3.2 percent in 2024 and further to 3.5 and 3.8 percent in 2025 and 2026, respectively (Table 1.1). Risks to the outlook remain tilted to the downside. Persistent weakness in global 1. Overview 3 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 growth, and especially in the Eurozone, would the countries from the region still need to deal translate into weaker investment and trade with: (i) remaining state-owned enterprises with the WB6. Similarly, there are a number (SOEs) that are inefficient and create distortions of domestic factors that put the baseline to market competition; (ii) education systems set of projections at risk including flare-ups that fail to deliver the skills demanded by in geopolitical tensions, increased outward (future) markets; (iii) public sector institutions migration, electoral uncertainty in several that function poorly; and (iv) gaps in critical countries, and persistent inflation. infrastructure, which raises the costs of doing business and is prone to climate change- However, while the WB6 region is expected related disasters. Addressing these problems— to return on its pre-pandemic trend in 2024, SOEs, governance, education and climate this is insufficient to enable meaningful change—with comprehensive, sustainable, and convergence with EU income levels over adequately funded policy responses, would the medium term. While growth rates for unleash significant growth potential. individual countries are expected to be between 2.5 and 4 percent over the projection period, The spotlight in this edition of the Western thus leading to average regional growth above Balkans Regular Economic Report focuses the pre-pandemic trend, this is insufficient to on the role of cities as engines of growth and provide faster convergence with the EU in terms leading actor in the green transition. Cities of income per capita. Measured in purchasing in the Western Balkans are often small and power parity (PPP) terms, GDP per capita in sparsely populated, and they are experiencing the Western Balkans remains at just 40 percent demographic decline, limiting the potential of the EU average. of agglomeration economies. The average city is small, with only 30,000 inhabitants, But, the EU’s new Growth Plan for the and population density is low, at around Western Balkans offers an opportunity to 942 inhabitants per square kilometer. This catalyze growth-enhancing reforms and is lower than other countries in Europe and investments. Approved by the EU in late 2023, Central Asia (ECA) or in most of the world. the new Growth Plan provides a much-needed These characteristics do not lend themselves mixture of resources for critical infrastructure to agglomeration economies, and thus limit investments, as well as an impetus for structural the potential contribution that urban areas reforms. Efforts to improve integration with can make to overall productivity and national the single market, particularly through trade economic growth. Nevertheless, greening urban and transport facilitation measures as well as development provides an opportunity not via access to the Single Euro Payments Area, only to counteract the effects of demographic in particular, are expected to provide a boost to decline, but also to promote greener growth in growth over the medium term. cities and at the national level. The structural reform agenda remains critical A changing climate has further increased in order to invigorate growth in the Western vulnerabilities, with Western Balkan cities Balkans toward faster and more sustainable exposed to multiple natural hazards, extreme improvements in living standards. Most of heat and poor air quality. Extreme heat in 4 1. Overview INVIGORATING GROWTH cities has worsened considerably. For instance, Tirana, Shkodra, Vlora, Mostar, Sarajevo, and Skopje are up to 4.5–7.5°C hotter in summer compared with their rural surroundings. Many cities in the region exceed safe PM2.5 levels and are among the most polluted in Europe. Skopje’s annual mean PM2.5 levels are 4.5 times and Sarajevo’s levels are triple the recommended safe level set by the World Health Organization. These cities, along with Belgrade and Pristina, are among the most polluted capitals in Europe. This spotlight recommends action on three main fronts to make cities in the Western Balkans greener. First, it is crucial to reduce urban sprawl and make cities more compact. This can be done via investments to regenerate urban areas to increase density, to encourage mixed use of land in core areas, and the redevelopment of brownfields. Second, cities must bring down their emissions, also because this will have immediate improvement on socio-economic and environmental outcomes. The focus should be on key sectors including transportation, buildings, and waste management—which will directly target CH4, CO2, PM2.5 emissions, and directly impact human health and livability. And third, cities must take actions to reduce extreme urban heat and enhance preparedness for it. Measures, such as green roofs, urban parks and gardens, and constructed wetlands, should be promoted given their low implementation costs, and high environmental and social co-benefits, while hard and soft heat adaptation measures, such as shading and extreme heat early warning systems should also be implemented to reduce the effect of heatwaves on human health. 1. Overview 5 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Table 1.1. Western Balkans Outlook, 2020–26 2020 2021 2022 2023e 2024f 2025f 2026f Real GDP growth (percent) Albania -3.3 8.9 4.9 3.3 3.3 3.4 3.5 Bosnia and Herzegovina -3.0 7.4 4.2 1.9 2.6 3.3 4.0 Kosovo -5.3 10.7 4.3 3.1 3.7 3.9 3.9 North Macedonia -4.7 4.5 2.2 1.0 2.5 2.9 3.0 Montenegro -15.3 13.0 6.4 6.0 3.4 2.8 3.0 Serbia -0.9 7.7 2.5 2.5 3.5 3.8 4.0 WB6 -3.0 7.9 3.4 2.6 3.2 3.5 3.8 Real GDP components growth (percent) Consumption -1.1 4.8 3.1 1.7 2.8 2.7 2.7 Investment -1.6 2.1 1.3 -0.8 1.3 1.2 1.3 Net exports -0.3 -0.4 -1.8 1.7 -1.0 -0.4 -0.2 Exports -5.6 9.9 6.6 1.0 2.3 3.3 3.3 Imports (-) -5.4 10.3 8.3 -0.6 3.3 3.7 3.6 Consumer price inflation (percent, period average) 1.0 3.2 11.8 9.0 3.9 2.7 2.4 External sector (percent of GDP) Goods exports 21.4 25.2 28.5 25.4 26.5 26.6 26.8 Trade balance -19.4 -16.7 -18.7 -15.4 -16.7 -16.5 -16.1 Current account balance -8.6 -5.8 -7.8 -4.9 -5.5 -5.7 -5.5 Foreign direct investment 5.3 5.9 6.9 5.4 5.3 5.3 5.3 External debt 87.8 82.8 75.3 71.3 58.2 57.2 46.3 Public sector (percent of GDP) Public revenues 34.7 35.9 34.8 36.5 36.3 36.5 36.7 Public expenditures 42.5 38.8 37.5 38.0 38.9 38.7 38.9 Fiscal balance -7.9 -3.0 -2.7 -1.5 -2.7 -2.2 -2.4 Public and publicly guaranteed debt 60.2 56.5 50.4 47.3 47.5 46.7 42.7 Sources: National statistical offices; Ministries of Finance; central banks; World Bank staff estimates. Note: e = estimate; f = forecast. 6 1. Overview INVIGORATING GROWTH 2. Growth returned to its pre-pandemic average, reflecting regional developments and countries’ characteristics Growth in the Western Balkans is estimated economies (Albania, Montenegro, Kosovo) at 2.6 percent in 2023, moderating from benefiting most from the re-opening of 3.4 percent reached in 2022, reflecting the tourism and international travel. This duality impact of various regional developments was partly reconciled over the course of 2023, (Figure 2.1). Russia’s invasion of Ukraine has  due to a normalization in the pattern of had an adverse impact on growth in the EU, economic activities, as the sources of growth a key trading partner for the WB6. The EU's returned to trend. At the same time, Serbia sizable growth slowdown in 2023, plummeting and Montenegro surprised with a stronger- from 3.6 percent in 2022 to an estimated than-expected GDP growth, estimated at 2.5 0.6 percent in 2023, rippled across the region, and 6 percent, respectively. On the other hand, impacting both exports from the Western while Albania and Kosovo are now estimated to Balkans and, to a lesser extent, remittances. The have grown at 3.3 and 3.1 percent, respectively, global situation has been further complicated by in 2023, down from 3.6 and 3.2 percent, the outbreak of the conflict in the Middle East respectively, from previous projections, which, coupled with supply chain disruptions growth rates for Bosnia and Herzegovina, and in the Red Sea and Suez Canal, introduced North Macedonia have been reduced to 1.9 additional layers of global uncertainty. and 1.0 percent, respectively, from 2.2 and Container shipping rates have surged in early 1.8 percent (Figure 2.1). 2024, accompanied by increased shipping times. However, the impact on global trade As of end-2023, growth rates returned to, or flows compared with the disruptions witnessed just below, pre-pandemic low averages, with in 2021–22 due to the pandemic has been the exception of Montenegro and Albania. relatively subdued. This is attributed to lower As shown in Figure 2.2, real GDP surpassed demand pressures, expanded shipping capacity, the 2019 levels in all WB6 countries, but and reduced congestion in ports. progress was less marked in North Macedonia, which experienced the slowest recovery of the Growth performance surprised positively in WB6 post-pandemic. At the same time, as real Serbia and Montenegro, while the other four GDP recovered from the crises, GDP growth countries performed below expectations. rates also normalized. With the post-pandemic The post-pandemic recovery throughout recovery boost dissipating, growth rates 2021 and 2022 displayed strong duality in returned to their pre-pandemic averages, or the performance of WB6 countries—with even below, with the exception of Montenegro manufacturing-oriented economies (Serbia, and Albania (Figure 2.1). Bosnia and Herzegovina, North Macedonia) mostly affected by the slowdown in the EU (especially in Germany) and services-oriented 2. GROWTH RETURNED TO ITS PRE-PANDEMIC AVERAGE, REFLECTING REGIONAL DEVELOPMENTS AND COUNTRIES’ CHARACTERISTICS 7 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Figure 2.1. Growth in 2023 is estimated Figure 2.2. Real GDP comfortably at 2.6 percent, below the pre-pandemic surpassed 2019 levels average Real GDP growth, percent 2019=100 14 115 12 110 10 105 8 100 6 95 4 90 2 85 0 80 ALB BiH KOS MKD MNE SRB EU27 2019 2020 2021 2022 2023e J 2015–19 avg J 2021 J 2022 J 2023e ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB Source: National statistical offices and World Bank staff estimates. Source: National statistical offices and World Bank staff estimates. Figure 2.3. Consumption remains the Figure 2.4. Given the medium to high main growth driver in most WB6 countries trade openness, trade is key to growth for the WB6 Contribution to growth, 2012–19 vs 2023 As a percent of GDP, 2022 8 180 6 160 4 140 2 120 0 100 -2 80 -4 60 -6 40 -8 20 20 9 e 20 9 e 20 9 e 20 9 e 20 9 e 20 9 e –1 –1 –1 –1 –1 –1 23 23 23 23 23 23 0 12 12 12 12 12 12 20 20 20 20 20 20 ALB BiH KOS MKD MNE SRB ALB BiH KOS MNE MKD SRB J Consumption J Investment J Trade J Exports J Imports J Net exports Q Real GDP growth (percent) Source: National statistical offices and World Bank staff estimates. Source: National statistical offices and World Bank staff estimates. An important channel that helps explain the indicators—but this did not contribute as WB6 countries’ over/under-performance significantly as expected to growth, due relative to expectations remains external to a combination of a high base effect and trade. This is particularly the case for Serbia the prevailing informality in the tourism and its stronger-than-expected economic sector, which prevented sectoral growth from performance in 2023, while the negative or translating into economic growth. Hence, minimal contribution to growth from trade the overall contribution from net exports to contributes to the downward revision to growth was only 0.6 of a percentage point, growth for Bosnia and Herzegovina, Kosovo, in line with the pre-pandemic average. All and North Macedonia (Figure 2.3). In Albania, countries with trade openness levels of between external demand, especially for tourism-related 80 and 140 percent of GDP have much to services, remained robust—as captured by the gain from enhancing regional integration. record number of tourist arrivals and related Other countries, such as North Macedonia, 8 2. GROWTH RETURNED TO ITS PRE-PANDEMIC AVERAGE, REFLECTING REGIONAL DEVELOPMENTS AND COUNTRIES’ CHARACTERISTICS INVIGORATING GROWTH with overall trade already at 171 percent of of the previous year, which was mostly due to GDP, are not only highly exposed to regional supply chain disruptions. The acceleration in trade dynamics, but would also require the the construction sector led most of the private implementation of domestic structural reforms investment growth observed in 2023, as well as to benefit further from greater integration the increase in housing prices. (Figure 2.4). Figure 2.5. Construction has picked up in 2023, for Albania and Serbia In Albania, Kosovo, and Montenegro, Number of building permits (Q1 2019 =100) private consumption remained the key driver 600 of growth in 2023, while private and public 500 investment started to pick up  (Figure 2.3). 400 In Montenegro, solid private consumption 300 growth in the first half of the year stood out, 200 underpinned by higher public sector wages, employment gains, and household borrowing. 100 Nevertheless, it slowed down in the second half 0 1 1 2 19 3 4 2 1 2 2 3 20 0q4 2 1 2 2 3 4 2 1 2 2 3 4 23 1 2 23 3 q4 20 19q 20 20q 20 21q 20 22q 20 23q 20 9q 20 9q 20 0q 20 1q 20 2q 20 q 2020q 20 1q 2022q 2023q 20 q 20 1q 20 2q of 2023. Given a more optimistic stance in the 2 1 20 ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB Eurozone, with interest rates expected to have Source: National statistical offices and World Bank staff estimates. passed their peak, private investment began Note: Data for Kosovo are proxied by data for Pristina. to pick up, as seen in Albania and Kosovo. In Bosnia and Herzegovina, subdued exports Favorable weather translated into positive and stagnant investment were offset in part contributions to growth from the energy by stronger government consumption. After and agriculture sectors, also thanks to providing a negative contribution to growth in the normalization in commodity prices. 2022, investment in Kosovo grew by 3.5 percent In Albania and Montenegro, electricity (yoy) during Q1–Q3 2023, accompanied production contributed positively to growth, by substantial increases in public investment while in Kosovo agriculture recorded a positive program implementation (32.5 percent). performance, favored by decreasing agricultural input prices. Similarly, in Serbia, the recovery From the supply side, beyond trade and in agriculture contributed to stronger-than- tourism-related services, construction also expected growth, especially in the second half contributed significantly to growth, as of the year. Meanwhile, the contribution from shown by the increasing number of building the agriculture sector remained close to null in permits ( Figure 2.5). While services led North Macedonia and negative in Albania and growth across the WB6 countries, construction Montenegro. became an important engine for growth, particularly in Albania and Serbia, while it contributed negatively to growth in North Macedonia and Montenegro. In Albania, the acceleration in the construction sector rose by double digits, at almost 15 percent in Q2 2023, also reflecting the low comparative base 2. GROWTH RETURNED TO ITS PRE-PANDEMIC AVERAGE, REFLECTING REGIONAL DEVELOPMENTS AND COUNTRIES’ CHARACTERISTICS 9 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 3. Employment growth slowed in 2023, as economic growth continued to slow1 Employment growth continued to lag Employment continued to decline in the throughout 2023 across the WB6 countries, agriculture sector but strengthened in with the exception of Bosnia and Herzegovina construction and services. In Q4 2023, the (Figure 3.1). After employment declined in the  strongest employment growth was seen in second half of 2022, it recovered through the construction (8.7 percent yoy) led by a double- summer of 2023 in most WB6 countries. The digit growth in North Macedonia as it prepares overall number of employed increased by about for the highway construction, and services 98,700 in 2023 on an annual basis. Positive (2.8 percent), while public administration contributions came from all countries except employment also strengthened (0.8 percent) for North Macedonia which observed a decline (Figure 3.3). Agricultural employment in the number of employed. Kosovo displayed increased only in Montenegro, while in the robust employment growth coming out of other WB6 countries, a decline continued the pandemic, but employment decelerated despite increased subsidies to the agriculture from late 2022. However, employment levels sector aimed at containing the impact of food across all WB6 countries, except for North inflation and increased import substitution. Macedonia, are above the pre-crisis levels, Public sector employment saw a rise across with Montenegro, North Macedonia, and all WB6 countries. Retail trade, information Bosnia and Herzegovina numbers affected by and communications technology (ICT), and a methodological change (Figure 3.2). This tourism in Montenegro increased employment is similar to the post-pandemic rebound in by double digits compared with 2022, while in economic growth, which was slower for North Serbia construction sector employment gained Macedonia than for the rest of WB6 countries. strength in the second half of 2023. Figure 3.1. Employment growth was Figure 3.2. In all WB6 countries except modest in 2023 North Macedonia, employment levels are above their pre-pandemic levels Two-quarter averages, percent yoy employment growth, percent December 2019 = 100 10 40 120 8 6 30 115 4 110 2 20 0 105 -2 10 -4 100 -6 -8 0 95 -10 -12 -10 90 -14 85 -16 -20 M r-21 Ju 21 Se l-21 No -21 Ja -21 M -22 M r-22 Ju 22 Se l-22 No -22 Ja -22 M -23 M r-23 Ju 23 Se l-23 No -23 23 80 - - - v- ay p v ay ay n p v n p a a a Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 M ▬ ALB ▬ MKD ▬ SRB  WB6 ▬ BiH rhs ▬ MNE rhs ▬ KOS rhs ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB ▬ WB6 Source: National statistical offices and World Bank staff estimates. Source: National statistical offices and World Bank staff estimates. 1 This analysis was affected by: (i) delayed publishing of Labor Force Survey (LFS) data in Kosovo; (ii) a sampling revision in Bosnia and Herzegovina, Montenegro, and North Macedonia in 2021–22 that reduced comparability with previous LFS data. Using administrative unemployment and tax administration data for Kosovo helped provide an approximate picture of the labor market from Q1 2023. 10 3. Employment growth slowed in 2023, as economic growth continued to slow INVIGORATING GROWTH Figure 3.3. Construction and services Figure 3.4. The employment rate gained strength, while agriculture increased compared to 2022 continued to decline Employment level, 15+ years, percent, annual change 15+ years, 2023–22, percentage change 10 WB6 1.0 8.7 8 6.8 1.6 KOS 6 5.3 1.3 3.6 4 BiH 2.9 2.8 2.7 2.6 2.6 2.5 2.4 2.0 1.9 2 1.7 1.6 1.5 1.4 1.4 1.4 1.2 -1.8 1.0 1.0 0.8 0.8 0.7 0.7 MKD 0.6 0.6 0.4 0 0 -0.1 -0.4 -0.5 0.7 -2 SRB -1.4 -2.1 -4 -3.6 5.3 MNE -4.7 -6 -5.5 -6.1 -6.2 1.7 -8 ALB General Agriculture Industry Construction Services government 0 10 20 30 40 50 60 J Q1-22 J Q2-22 J Q3-22 J Q4-22 J 2023 J 2022 J Q1-23 J Q2-23 J Q3-23 J Q4-23 Source: National statistical offices and World Bank staff estimates. Source: National statistical offices and World Bank staff estimates. Note: employment growth is weighted average. Figure 3.5. Unemployment rate declined Figure 3.6. Youth unemployment rate in all WB6 countries in 2023 was more than double the overall unemployment rate 15+ years, percent, and 2022–2023, percentage change Percent WB6 -0.9 50 -0.1 SRB 40 -0.3 29.9 ALB 29.4 30 25.7 25.5 25.5 23.7 -3.7 KOS 16.9 -1.3 20 MKD -1.6 10 MNE -2.2 BiH 0 0 2 4 6 8 10 12 14 16 ALB BiH KOS MKD MNE SRB WB6 J 2023 J 2022 J 2019 J 2020 J 2022 J 2023 Source: National statistical offices and World Bank staff estimates. Source: National statistical offices and World Bank staff estimates. Figure 3.7. More people joined the WB6 Figure 3.8. Female to male labor labor force participation gap narrowed to 18 percentage points Percent of population aged 15+ Labor force participation, percent MNE 63.9 80 70 64.1 ALB 60 55.6 SRB 50 52.3 40 MKD 30 47.8 BiH 20 38.8 10 KOS 0 Dec-18 Dec-21 Dec-22 Dec-23 Dec-18 Dec-21 Dec-23 Dec-18 Dec-23 Dec-18 Jun-18 Dec-18 Dec-22 Dec-21 Dec-22 Dec-21 Dec-23 Dec-22 Dec-21 Dec-23 Dec-22 Dec-21 Mar-23 Dec-22 54.0 WB6 0 10 20 30 40 50 60 70 MNE ALB SRB MKD BiH KOS J 2023 J 2022 J 2019 Q Male Q Female Source: National statistical offices and World Bank staff estimates. Source: National statistical offices and World Bank staff estimates. Note: Kosovo shows Q1 2023. 3. Employment growth slowed in 2023, as economic growth continued to slow 11 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 The WB6 employment rate (15+, weighted double the overall unemployment rate. average) reached a new historical high of The youth unemployment rate declined to 48.1 percent in 2023 (  Figure 3.4). The largest 25.5 percent, 1.6 percentage points below the annual increases were registered in Montenegro average 2022 rate (Figure 3.6). This was still and Albania, at 5.3 and 1.7 percentage points, well above the youth unemployment rate in the respectively. Albania remained the frontrunner EU, which stood at 13.8 percent in 2023. There in the WB6, with the highest employment rate were 154,900 young people unemployed in the of 57.2 percent in 2023, although Montenegro WB6 countries in 2023, some 15,700 fewer gained speed throughout 2022 and 2023, than in 2022. The lowest youth unemployment reaching 55.6 percent in 2023. At 50.3 percent, rate was seen in Kosovo at 16.9 percent, Serbia increased slightly its employment rate followed by Montenegro. The highest youth compared with 49.6 percent in 2022, despite unemployment rate was registered by Bosnia stronger-than-expected growth performance. and Herzegovina, at 29.9 percent in 2023—the Although its employment rate increased, country with one of the largest world diasporas employment in Kosovo remained low at of younger migrants. Despite improvements, estimated 35.4 percent in 2023. the young people in the WB6 countries continue to experience high rates of inactivity, Unemployment declined across all WB6 high shares of informal-sector employment, countries, with the overall unemployment skills mismatches, and continued emigration. rate reaching 10.9 percent in 2023  (Figure 3.5). In 2023, there were on average 824,500 The labor force participation rate improved people unemployed in the WB6 region, over the course of 2023 at the WB6 regional equivalent to 7.3 percent or 64,700 people level (Figure 3.7). The participation rate fewer than a year ago. On average, Kosovo, averaged 54 percent in 2023, 0.5 of a percentage Bosnia and Herzegovina, and North Macedonia point higher than in 2022, with the gains recorded the largest nominal declines on an coming from all WB6 countries except North annual basis in the number of unemployed, Macedonia. The labor force participation rate of 31, 14, and 11 percent yoy, respectively. In reached 64.1 percent in Albania—a record for North Macedonia, this is explained by a rise in the WB6 region. The lowest ratio of population inactivity, while in other WB6 countries people participating in the labor market was in Kosovo moved to new jobs. Albania, Kosovo, North and this has seen almost no improvement Macedonia, and Montenegro reached their since 2021. The increase in the labor force historically lowest annual unemployment rates. participation rate partly reflected a decline The lowest unemployment rates in the WB6 in the working age population. Namely, the region were observed in Kosovo and Serbia, working age population over the past year at 8.8 and 9.5 percent in 2023, while Bosnia declined across all WB6 countries, except for and Herzegovina’s unemployment rate was the North Macedonia, reflecting population aging highest, at 13.2 percent. and migration outflows. The region made impressive efforts to The improvement of the labor force bring the youth unemployment rate down participation rate was the result not only following the pandemic; however, it remains of women, but also men, entering labor 12 3. Employment growth slowed in 2023, as economic growth continued to slow INVIGORATING GROWTH markets in Albania, Montenegro, Kosovo, result of the automatic indexation of minimum and Bosnia and Herzegovina ( Figure 3.8). wages introduced in several countries, strong The most pronounced increase in female public sector wage bargaining, and a record labor force participation was in Montenegro, shortage of workers in the private sector. at 3.5 percentage points (pp), Kosovo at 1.6 pp, and Bosnia and Herzegovina, at Figure 3.9. Average real wage and productivity growth, 2015–2023 1.3 pp by December 2023. With a female labor axis participation rate of 57.7 percent, Albania 3 set the record for the WB6 region. Advances were seen in Montenegro’s male labor force 2 participation as well (at 71.3 percent being the lead in the region). Female participation 1 rates were also above the regional average 0 of 44.2 percent in Montenegro and Serbia, while the gender gap in Albania narrowed the -1 most—to 12.8 percentage points. After two ALB BiH KOS MNE MKD SRB J Wages J Productivity years of improvements, the female-to-male Source. National statistical offices. participation gap for the region increased Note. Historical productivity estimates are obtained using average hours worked per week, number of employees from Labor Force by 0.5 pp over 2023, to 19.7 percent, with Survey (LFS) and real output. Estimates for 2023 are obtained using World Bank staff forecasts and assuming no change in average a stark difference of over 34 pp in Kosovo. hours worked per week. Bringing more workers into the labor market and increasing labor productivity will be Real wages do not reflect productivity growth crucial to support future growth. However, in most of the WB6 countries since 2015. visa liberalization in Kosovo,2 the relaxed This is likely due to underlying firm dynamics work permitting in some EU countries (such (low productivity improvements through as Germany), and aging create further adverse sectoral reallocation, between and within pressures on the labor market (see Box 3.1). firms’ reallocation), but also low public sector productivity. On the other side, minimum While inflation outpaced wages despite their wage reforms, public sector bargaining power, double-digit growth across the WB6 region and labor supply shortages widened the wage- in 2022, real wages increased in 2023. In productivity growth differential for most of the 2022, real wages declined in all WB6 countries, WB6 countries.3 This gap was most notable for most notably in Bosnia and Herzegovina where Albania and Bosnia and Herzegovina, where the annual decline averaged 8.7 percent. In the real wages increased at double-digit rates, other WB6 countries real wages fell between despite low or declining productivity. Real 1.0 and 3.5 percent. Meanwhile, in 2023, wages also rose by more than productivity in real wages increased by 8.4 percent on average Serbia, Montenegro, and North Macedonia, across the WB6, comfortably surpassing the in particular for manufacturing, construction productivity growth of 0.2 percent. This was a and public sector workers, where wages grew 2 https://www.kosovo-online.com/en/news/analysis/kosovo-rapidly-losing-its-workforce-what-follows-after-visa-liberalization-29-10-2023. 3 2023 wage data for Kosovo are not available. 3. Employment growth slowed in 2023, as economic growth continued to slow 13 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 faster than the average wage. High emigration firms increasingly battled with labor availability and population aging continued to aggravate and a brain drain,4 despite a positive wage- labor market distortions in the WB6 region, as productivity growth gap (Figure 3.9). Box 3.1. Labor markets in the Western Balkans: navigating demographic shifts and emigration Changes in total hours worked can be decomposed into the impacts of five factors. Following the recent approach of the International Monetary Fund (IMF),5 growth of total hours worked can be decomposed into the impacts of: (i) growth of average hours worked per employed person; (ii) total population growth; (iii) employment rate; (iv) participation rate; and (v) the share of the working age population. However, recent changes in labor force survey methodologies and new census data have limited the cross-country comparability of the data.6 Also, the 2020–2022 period should be interpreted with caution, given the pandemic-related fluctuations. Overall, the WB6 region has experienced a rise in total hours worked driven by employment growth and labor force expansion, while population has declined. From 2014 onward, all WB6 countries have seen a rise in total hours worked, although the pandemic did slow the rate at which total hours worked increased (Figure 3.10). Trends in average hours worked are highly variable across WB6 countries and time, preventing a clear trend from emerging. The most significant demographic challenge was the decline in populations in Bosnia and Herzegovina, Kosovo, North Macedonia, and Serbia. However, labor market dynamics largely mitigated this negative impact on total hours worked. The working age population in the WB6 remained relatively stable for most countries, while labor force participation witnessed diverse trends across countries. Albania, Montenegro, and Serbia witnessed notable increases in labor force participation rates between 2014 and 2022, although the upward trend is losing momentum. Kosovo and North Macedonia experienced variable participation rates, while Bosnia and Herzegovina has witnessed a decline in its labor force since 2011. Importantly, since 2014, all WB6 countries have enjoyed consistent positive growth in employment rates, a trend that has withstood the challenges of the pandemic. 4 https://www.rcc.int/balkanbarometer/key_findings/1/business. 5 IMF: Regional Economic Outlook Europe, 11/23. Chapter 2: Wage Dynamics in Europe: Are Labor Markets Heralding More Inflation? Online Annex. https://www.imf.org/en/Publications/REO/EU/Issues/2023/10/13/regional-economic-outlook-for-europe-october-2023. 6 Bosnia and Herzegovina’s labor market data prior to 2020 have been revised using new census data, affecting comparability. The 2020 growth rate is excluded from the chart due to a fourfold increase in the survey sample size in 2021. In Montenegro, LFS interviews quadrupled in 2022, aligning with Eurostat standards, which impacts comparability with previous years. Kosovo’s average work hours data are estimated from employment-weighted averages of employment by hours of work in intervals due to the poor quality of the data. North Macedonia’s 2021 and 2022 data lack comparability due to methodological changes and new census data; thus, new rates are applied to old population numbers. The 2021 and 2022 average hours worked were not reported to Eurostat, hence the same estimation method as in Kosovo was applied. 14 3. Employment growth slowed in 2023, as economic growth continued to slow INVIGORATING GROWTH (Box 3.1 continued) Figure 3.10. Change in total hours worked and contributions Albania Bosnia and Herzegovina Annualized growth, percent, weighted average Annualized growth, percent, percentage change 6 6 5 5 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 2014–16 2017–19 2020–22 2008–10 2011–13 2014–16 2017–19 2021–22 Kosovo Montenegro Annualized growth, percent, weighted average Annualized growth, percent, weighted average 8 6 5 6 4 4 3 2 2 1 0 0 -2 -1 -4 -2 2014–16 2017–19 2020–22 2008–10 2011–13 2014–16 2017–19 2020–22 North Macedonia Serbia Annualized growth, percent, weighted average Annualized growth, percent, weighted average 4 5 3 4 2 3 2 1 1 0 0 -1 -1 -2 -2 -3 -3 2011–13 2014–16 2017–19 2020–22 2011–13 2014–16 2017–19 2020–22 J Average hours worked J Change in employment J Labor force participation J Working age population J Population Q Total hours worked Sources: National statistical offices, Eurostat, World Bank staff calculations. Note: See Footnote 6 for a methodological explanation. Women have contributed significantly in the WB6 countries, with their annual increase in total hours worked outpacing that of men across all WB6 countries. Between 2013 and 2022, women’s average yearly contribution to overall total hours worked exceeded that of men by 2 percentage points in Albania, and 1.4 percentage points in Serbia (Figure 3.11). The primary driver for this disparity is a marked rise in women’s employment rates. Furthermore, women’s higher participation rates contributed to this trend in all WB6 countries, including in Kosovo where it was disproportionately low. 3. Employment growth slowed in 2023, as economic growth continued to slow 15 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 (Box 3.1 continued) Figure 3.11. Change in total hours worked and contributions: disaggregated by gender Albania Bosnia and Herzegovina Annualized growth, percent, weighted average Annualized growth, percent, weighted average 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -4 -4 Men Women Men Women Men Women -6 Men Women Men Women Men Women Men Women Men Women 2014–16 2017–19 2020–22 2008–10 2011–13 2014–16 2017–19 2021–22 Kosovo Montenegro Annualized growth, percent, weighted average Annualized growth, percent, weighted average 14 7 12 6 10 5 8 4 6 3 4 2 2 1 0 0 -2 -1 -4 -2 -6 Men Women Men Women Men Women -3 Men Women Men Women Men Women Men Women Men Women 2014–16 2017–19 2020–22 2008–10 2011–13 2014–16 2017–19 2020–22 North Macedonia Serbia Annualized growth, percent, weighted average Annualized growth, percent, weighted average 5 6 4 5 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 Men Women Men Women Men Women Men Women -4 Men Women Men Women Men Women Men Women 2011–13 2014–16 2017–19 2020–22 2011–13 2014–16 2017–19 2020–22 J Average hours worked J Change in employment J Labor force participation J Working age population J Population Q Total hours worked Sources: National statistical offices, Eurostat, World Bank staff calculations. Note: See Footnote 6 for a methodological explanation. Recently, the WB6 countries have been reforming their immigration policies to meet growing labor demand, to counteract the demographic decline and emigration of workers to the EU. The WB6 region is increasingly becoming a destination for migrants from less affluent countries, particularly in the ICT, construction and hospitality industries. Russia’s invasion of Ukraine has prompted many Russians and Ukrainians to migrate to the Western Balkans as well. Bosnia and Herzegovina’s foreign workforce has doubled since 2020, 16 3. Employment growth slowed in 2023, as economic growth continued to slow INVIGORATING GROWTH (Box 3.1 continued) with about 3,500 work permits issued by the end of 2023.7 Montenegro has seen a 2-percent increase in its population, primarily due to the arrival of foreign nationals.8 Serbia, from February 2024, has eased its policies, allowing work with a temporary residence permit, and offering the prospect of permanent residency after three years.9 Albania, having introduced a Single Permit system in 2021, has streamlined the process for foreign workers and extended residence permits to five years, which has led to a rise in the number of foreign residents.10 7 https://sarajevotimes.com/there-are-3500-foreign-workers-in-bih/. 8 https://balkaninsight.com/2024/01/26/montenegros-population-rise-linked-to-influx-of-foreigners-demographers-say/. 9 https://statt.rs/3-dramatic-changes-of-legal-requirements-for-foreigners-in-2024/. 10 https://kpmg.com/al/en/home/insights/2021/10/new-law-on-foreigners.html. 3. Employment growth slowed in 2023, as economic growth continued to slow 17 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 4. The pace of poverty reduction has slowed and vulnerabilities persist Poverty in the Western Balkans returned Figure 4.1. Poverty is expected to decline to its declining trend during 2023, but at a at a slower rate in the WB6 Poverty headcount, percent of population living on less than $6.85/ slower pace than pre-pandemic  (Figure 4.1). day, 2017PPP The pace of poverty reduction is closely linked 40 to the pace of economic growth and is highly 30 impacted by the various shocks that affect 29.2 households’ income-generating ability. The 26.7 23.1 20 overall pace of poverty reduction is forecast 19.3 19.4 15.8 to slow down from over 3 percentage points 10 14.3 13.4 12.5 11.7 annually pre-pandemic to roughly 1 percentage point annually between 2022 and 2025, the 0 16 17 e e e e f f f f 22 23 24 25 forecast period. This flattening of the poverty 18 19 20 21 20 20 20 20 20 20 20 20 20 20 reduction trend is due to decelerating growth Source: World Bank estimates and forecasts based on 2021 income data from the Survey of Income and Living Conditions (SILC) for in the region, to the sharp increases in the Montenegro; 2019 for Albania and North Macedonia; 2021 for Serbia; and 2017 Household Budget Survey (HBS) for Kosovo. prices of food and energy during 2022–2023, Note: Income and consumption measures from the SILC and the HBS, respectively, are not strictly comparable. Welfare is estimated which strained households’ purchasing power, in US dollars using 2017 PPPs. Due to a lack of comparable data, the regional estimate excludes Bosnia and Herzegovina (BiH). Forecasts are based on GDP per capita in constant LCU, e = estimate, f = and to the decline in real wages in 2022 (see forecast. Section 3, and also Regular Economic Report No.23, Spring 2023). Although inflation fell in The level of vulnerability to income shocks 2023 and is forecast to continue decelerating remains high despite progress on poverty through the remainder of the forecast period, its reduction. Data from the recent Life in cumulative effects continue to pose a challenge Transition Survey collected in 2023 reveal that, for lower-income households. in the Western Balkans, half of adults live in households that report just being able to make Poverty levels across the region have been ends meet or having to dip into savings or converging over time. Although poverty take on debt, and thus are not able to save any rates vary significantly across Western Balkan portion of their income. This compares with countries, they have been converging over time. only one-third in other ECA countries. Less The average deviation of each country’s poverty than one in every five adults in the Western rates from the regional mean has declined since Balkans are in households that are able to save 2020, and this trend is expected to continue. at least 10 percent of their income (Figure 4.2). The gap is forecast to narrow in 2024, with a This points to a high level of vulnerability to 13.5-percentage-point difference between the falling into poverty as the result of idiosyncratic countries with the highest and lowest poverty income shocks in the Western Balkans. Over rates (Albania and Serbia, respectively), down one-third of adults in the Western Balkans from nearly 24 percentage points in 2016. live in households that would not be able to cover more than two weeks of basic household expenses in the event of losing the main source 18 4. The pace of poverty reduction has slowed and vulnerabilities persist INVIGORATING GROWTH Figure 4.2. Many households are barely Figure 4.3. …and would not be able to making ends meet… cope with a sudden loss of main income source Percent Percent 60 100 9 50 80 20 21 40 60 16 24 30 40 20 15 35 10 20 22 0 0 Just making ends meet/ Saving 10% or more dissaving Western Balkans Other ECA J Western Balkans J Other ECA J >1 J 6–12 months J 3–6 months J 1–3 months J 2 weeks–1 month J <2 weeks J Refused/DK Source: Life in Transition IV data, 2023. Note: The graph reports the share of adult population living in households of each category. of household income. Half of the region’s the WB6 region also still faces the significant population would fail to cover household hurdle of low female labor force participation, expenses for longer than one month—a higher particularly in countries such as Kosovo (see degree of vulnerability compared with the ECA Box 3.1, and also Regular Economic Report, region’s average (Figure 4.3). No. 24, Fall 2023). Steady economic growth and job creation Future poverty reduction is faced with are expected to positively impact poverty continued threats from structural factors reduction. Over the past decade, all countries and shocks, such as inflation, demographic in the region have seen rising employment challenges, inadequate investments in rates and falling unemployment rates. Despite human capital, natural disasters or climate- significant variations in employment rates, related events, and the prevalence of low- they hit record highs in 2023. Concurrently, quality jobs. A skilled labor force is essential unemployment rates in the region converged for securing high-quality employment. Yet, to around 11 percent by the end of the year. results from the 2022 OECD’s Programme for Job creation appears to be a considerable factor International Student Assessment (PISA) reveal supporting poverty reduction. Yet, there is that all countries in the region scored below evidence of skill mismatches in the labor market, the international average on this assessment. with only just over half of those employed PISA measures 15-year-olds’ ability to use their reporting that their skills were the ones needed reading, mathematics, and science knowledge to carry out their duties, according to Life in and skills to meet real-life challenges. These Transition Survey data. Even among those results, and their negative trends across the with at least post-secondary education, over region, pose a significant obstacle to securing one-third felt overqualified for their current better employment and enhancing productivity roles, which underscores the challenges that and income, which are key to further reducing the region faces in terms of generating high- poverty. Demographic challenges include a quality jobs. Although progress has been made, decline in population and migration, especially 4. The pace of poverty reduction has slowed and vulnerabilities persist 19 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 among young people, who are the most likely to migrate. Additional challenges include external risks such as geopolitical tensions, global financial conditions, fluctuating commodity prices, and natural disasters or climate-related events, all of which can impact economic performance and poverty reduction efforts. 20 4. The pace of poverty reduction has slowed and vulnerabilities persist INVIGORATING GROWTH 5. Fiscal consolidation continued, amid rising pressures from current expenditure Fiscal consolidation gained ground in most Solid revenue performance, supported by Western Balkan countries over 2023. At higher direct taxation and grants receipts, led 1.5 percent of GDP, the region’s estimated the improvement of fiscal balances  (Figure average11 fiscal deficit for 2023 contracted 5.2). Despite the decelerating inflationary faster than previously expected, dropping by impetus, all WB6 countries experienced solid 1.2 percentage points (pp) of GDP from 2022, nominal revenue growth in 2023. Montenegro and falling to half of the level recorded in 2021 gained the most (4.3 pp of GDP) in public (Figure 5.1). Consolidation was particularly revenue during the year, but over half of this strong in Montenegro (5.3 pp of GDP), increase was explained by one-off revenues. which ended 2023 running a fiscal surplus, Other countries gained from 0.8 to 2.8 pp of and in Albania (2.3 pp of GDP). Bosnia and GDP. Serbia, the region’s largest economy, Herzegovina, on the other hand, was the only experienced a nominal revenue increase of WB6 country where fiscal policy meaningfully 11.9 percent from 2022, exceeding budget expanded, though its fiscal deficit level ranks projections, but its public revenues dropped among the lowest in the region, second only to by 0.5 pp as a share of GDP.12 One-off budget Kosovo. North Macedonia saw a modest rise in grants, primarily from the EU, contributed its level of the fiscal deficit (excluding state road to the rise in public revenues and the fiscal finances) from the previous year, and its deficit consolidation over 2023. Except for Bosnia remains the region’s highest since 2021. and Herzegovina, grants receipts accounted for a 0.5 pp of GDP increase in revenues, on average. Personal and corporate income Figure 5.1. Fiscal consolidation continued Figure 5.2. …against positive revenue to gain ground across the region… performance, and contained expenditures in Serbia and Albania Fiscal deficit, percent of GDP Contribution to change in the fiscal balance, percent of GDP, 2023e 1 6 ↑Reduced revenues, increased spending 0.5 0 4 -0.2 -1 -0.9 2 -1.4 -1.5 -2 -2.2 0 -3 -2 -4 -4.5 -5 -4 ↓Increased revenues, reduced spending -6 -6 MKD SRB ALB BiH KOS MNE WB6 BiH MKD KOS SRB ALB MNE WB6 J 2021 J 2022 J 2023e J Expenditure J Revenue Q Change in fiscal balance Sources: National statistical offices, ministries of finance and World Sources: National statistical offices, ministries of finance and World Bank staff estimates. Bank staff estimates. 11 From here on, the regional average refers to the regional unweighted arithmetic average. 12 Serbia’s economy is estimated to have grown by 14.8 percent yoy in 2023. 5. Fiscal consolidation continued, amid rising pressures from current expenditure 21 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 taxes, as well as social insurance contributions, of Montenegro and Serbia saw their current performed well across the region, mirroring expenditures rise (1.9 pp of GDP in Bosnia and increases in wages and profits. On the other Herzegovina and 0.2–1.6 pp of GDP for the hand, amid decelerating inflation, revenues rest), highlighting significant current spending from taxes on goods and services slowed down pressures. Given the rising sovereign financing compared with 2022 in all WB6 countries but costs over 2023, the region experienced an Montenegro (nominally contracting in Bosnia increase in interest payments, ranging from 0.8 and Herzegovina). Overall, Montenegro, percent of GDP in Serbia (from 1.5 percent Kosovo, and Albania experienced robust of GDP in 2022) to 0.2 percent of GDP in increases in total tax revenues as a percentage Albania (from 1.85 percent of GDP in 2022). of GDP. Bosnia and Herzegovina and Kosovo—the only two countries in the region without access to Current spending pressures, including for international debt markets—did not experience interest payments, remained high despite the any increase in interest payments (0.8 and overall contraction in expenditures in half of 0.4 percent of GDP in 2022, respectively). the WB6 countries. Expenditures increased in nominal terms across the WB6 region, but as a Public wages and social benefits dominated percentage of GDP they contracted in Serbia, current spending pressures in 2023. Social Albania, and Montenegro (1.3, 1.2 and 1.1 pp protection spending remained elevated at of GDP, respectively), mainly on account of an average of 12.7 percent of GDP, with lower capital spending and retraction of spending in Bosnia and Herzegovina, North inflationary crisis-related measures. Bosnia and Macedonia, and Serbia exceeding 13 percent of Herzegovina, Kosovo, and North Macedonia GDP (Figure 5.4). In Serbia and Montenegro, saw their expenditures rise as a percentage of despite of a contraction in total spending as a GDP (Figure 5.3). However, in contrast to percentage of GDP, social protection spending 2022, all WB6 countries with the exception continued to increase. Bosnia and Herzegovina Figure 5.3. Capital spending was Figure 5.4. …while all WB6 countries subdued… turned to higher spending on public wages and social benefits Percent of GDP Contribution to change, 2023e, percent of GDP 50 4 40 3 30 2 1 20 0 10 -1 0 2022 2023e 2022 2023e 2022 2023e 2022 2023e 2022 2023e 2022 2023e 2022 2023e -2 SRB MNE BiH MKD KOS ALB WB6 SRB ALB MNE KOS BiH MKD WB6 J Wage bill J Social benefits J Wage bill J Social benefits J Capital expenditures Q Total expenditures J Capital expenditures Q Total expenditures Sources: National statistical offices, ministries of finance and World Sources: National statistical offices, ministries of finance and World Bank staff estimates. Bank staff estimates. 22 5. Fiscal consolidation continued, amid rising pressures from current expenditure INVIGORATING GROWTH saw an estimated 16 percent nominal increase GDP. Consequently, public and publicly in subsidies, social benefits, and transfers in guaranteed (PPG) debt declined in most the Federation of Bosnia and Herzegovina WB6 countries, with the regional average (FBiH), and an 11 percent increase in the same of the PPG debt-to-GDP ratio falling from spending items in Republic of Srpska (RS). 50.4 percent in 2022 to 47.3 percent (Figure Kosovo is the only country in the region where 5.5). North Macedonia stood out as the sole social spending contracted compared with the exception, experiencing a 3-pp increase in PPG previous year, including because of a decline in debt as a share of GDP in 2023, attributing the number of social assistance beneficiaries. to a persistently high fiscal deficit and capital On the other hand, and after one year of lower spending borrowing. Montenegro recorded real public wages in 2022, all WB6 countries the most substantial decline in its PPG debt- saw increases in public wage compensation, to-GDP ratio, falling from 70.9 percent in averaging 0.4 pp of GDP, except Serbia where 2022 to an estimated 62.2 percent in 2023, it remained almost unchanged (as a percentage owing to robust nominal GDP growth and a of GDP). In Kosovo, Montenegro, and fiscal surplus. In Albania, the PPG debt-to- Albania, spending on wages and compensation GDP ratio returned to pre-pandemic levels, nominally increased by more than 15 percent driven by a blend of fiscal consolidation, from 2022. higher income, and the appreciation of the Albanian lek. Serbia experienced a reduction In half of the region’s countries, capital of 2.9 pp in its PPG debt-to-GDP ratio. In expenditure contracted as a percentage Kosovo, substantial amortizations in 2023, of GDP. Capital spending contracted more coupled with limited new borrowing led to a significantly in Albania (-1.4 pp of GDP) and reduction in the PPG debt-to-GDP ratio from Montenegro (-0.8 pp of GDP). Serbia, which 20 percent in 2022 to 17.4 percent in 2023. maintains the highest level of capital spending In addition, the denominator effect, significant to GDP in the region, saw a modest decline, debt repayment, and slow project disbursement from 7.2 percent of GDP in 2022 to 7.0 percent and implementation caused a 2 pp decrease in in 2023. In Kosovo and North Macedonia, PPG debt as a share of GDP in Bosnia and capital expenditures increased by around 1.0 Herzegovina. and 1.7 pp of GDP, respectively, mainly on account of higher spending on transportation While external PPG debt also declined, infrastructure. Bosnia and Herzegovina also it accounted for two-thirds of total PPG saw a modest increase in capital spending over debt. The external PPG debt-to-GDP ratio 2023 but, at 3.8 percent of GDP, it continued declined from 33.1 to 31.7 percent for the to maintain the lowest share of capital spending. WB6 region, due to higher nominal GDP and solid fiscal performance (Figure 5.6). Robust fiscal performance and solid GDP Montenegro’s external PPG debt remained growth led to a decline of public and the highest in the region at 54.1 percent of publicly guaranteed debt as a share of GDP. GDP in 2023, a decline of 7.7 pp from 2022, Although growth performances varied among owing to limited borrowing and a strong fiscal countries, GDP deflators remain elevated performance. Similarly, external PPG debt as a across the board, leading to higher nominal share of GDP declined in Albania and Bosnia 5. Fiscal consolidation continued, amid rising pressures from current expenditure 23 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Figure 5.5. Total PPG debt as a share of Figure 5.6. …thanks in part to a decline in GDP declined to its lowest in a decade… external PPG debt Percent of GDP Percent of GDP 90 70 80 60 70 50 60 50 40 40 30 30 20 20 10 10 0 0 MNE MKD ALB SRB BiH KOS WB6 MNE MKD SRB ALB BiH KOS WB6 J 2023e Q 2022 ▬ Pre-pandemic peak ▬ Pre-pandemic low J 2023e Q 2022 ▬ Pre-pandemic peak Sources: National statistical offices; World Bank staff estimates. Sources: National statistical offices; World Bank staff estimates. and Herzegovina, albeit marginally, by 0.6 and also expected to benefit from a new €6 billion 1.4 pp, respectively. Serbia’s external PPG debt financial instrument under the new Growth increased due to country’s borrowing to build Plan for the Western Balkans (see discussion in up liquidity buffers. Kosovo, and Bosnia and the Outlook section), adopted by the European Herzegovina remained the two countries with Commission (EC) in November 2023. the lowest share of external PPG to GDP, at 7.3 and 23.5 percent, respectively. Kosovo was After peaking in 2022, the cost of external also constrained by the required two-thirds of financing declined, but nonetheless remains votes needed to authorize the contracting of elevated. In recent years, many WB6 countries new external debt. Serbia, Kosovo, and North have grown more dependent on external Macedonia each have an active engagement financing and are susceptible to increasing with the IMF and, over the past six months, financing costs due to tightening monetary the IMF has carried out reviews and made policies. Following a hiatus in 2022, most WB6 available a total of €63 million for Kosovo, countries reengaged with the markets in 2023, €200 million for North Macedonia, and albeit in a significantly different environment. €400 million for Serbia, although the latter In 2023, Serbia issued two Eurobonds—a five- will be treated as precautionary. In 2023, the year Eurobond of US$750 million at a coupon World Bank provided additional financing rate of 6.25 percent, and a 10-year Eurobond of through development policy loans (DPLs) US$1 billion at a coupon rate of 6.5 percent. In approved for Kosovo (€50.6 million), Albania March 2023, North Macedonia issued a four- (€110 million), Serbia (€149.9 million), Bosnia year Eurobond of €500 million at a coupon and Herzegovina (€92 million), and North rate of 6.96 percent. In June 2023, Albania Macedonia (€94 million) that aim to assist issued a five-year €600 million at a coupon rate in strengthening the resilience of the WB6 of 5.9 percent. In March 2024, Montenegro countries’ economies and their environmental issued a seven-year US$750 million at a coupon sustainability. Additional DPLs for Serbia and rate of 7.25 percent. All these Eurobond Kosovo (all in the same amounts as in 2023) issuances incurred greater costs for the countries and the first DPL for Montenegro (€80 million) compared with the preceding two years, during are expected in 2024. All WB6 countries are which Serbia placed a Eurobond at a coupon 24 5. Fiscal consolidation continued, amid rising pressures from current expenditure INVIGORATING GROWTH rate of 1.0 percent and North Macedonia at Notwithstanding this, the credit rating agencies a coupon rate of 1.625 percent. As a result, confirmed the ratings of all countries (Table yields on the existing Eurobonds of Western 5.2), with the latest S&P ratings upgrading Balkan countries remain high, although they the outlook from stable to positive in Albania are, on average, around 1.0 pp lower than and Montenegro, having already raised the six months prior, with the sole exception of long-term local and foreign currency sovereign the RS’s Eurobond (Table 5.1). Spreads with credit ratings on Bosnia and Herzegovina to yields on German bonds have narrowed as well. ‘B+’ from ‘B’. Table 5.1. Yields on Western Balkans countries’ outstanding Eurobonds Yield in % Yield in % Yield in % Spreads Coupon Maturity (28 Mar 2023) (26 Sep 2023) (14 Mar 2024) (basis points) 3.5 16/06/2027 6.5 5.5 4.6 206.1 Albania 3.5 09/10/2025 6.1 5.5 4.4 103.9 2.785 16/12/2027 8.4 6.8 5.8 325.7 Montenegro 3.375 21/04/2025 7.3 5.9 4.9 147.9 6.96 13/03/2027 – 6.0 5.2 265.7 North Macedonia 2.75 18/01/2025 6.4 6.0 5.5 210.4 3.125 15/05/2027 5.8 6.2 4.5 202.5 Serbia 6.25 26/05/2028 – 6.8 5.8 341.4 Bosnia and Herzegovina, 4.75 01/01/2026 7.0 7.1 7.3 445.5 Republic of Srpska Source: https://www.boerse-frankfurt.de/en, accessed on 14 March 2024. Note: Spreads refer to spreads with yields on German bonds with the same or similar residual maturity. Table 5.2. Credit ratings of the Western Balkan countries Moody’s Standard & Poor’s Fitch Albania B1 (stable) B+ (positive) – Bosnia and Herzegovina B3 (stable) B+/B (stable) – Montenegro B1 (stable) B (positive) – North Macedonia – BB- (stable) BB+ (stable) Serbia Ba2 (stable) BB+ (stable) BB+ (stable) 5. Fiscal consolidation continued, amid rising pressures from current expenditure 25 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 6. Price increases have eased substantially, but inflationary pressures remain elevated After increasing to levels not seen in several inflation remained strongest in Montenegro, decades, inflation in the WB6 region where it stood at 7.4 in December 2023 (Figure decreased substantially during 2023, 6.4). In Albania, inflation expectations started mostly driven by decelerating international to reflect the persistence of price pressures: commodity prices (  Figure 6.1). At the regional one year ahead inflation expectations for level, after reaching its peak in October 2022 businesses and consumers increased at 6.0 and (15 percent), the Consumer Price Index (CPI) 11.2 percent respectively, considerably above witnessed a downward trend during 2023, the targeted band of 2.4 percent. Likewise, decreasing from 14.3 in January 2023 to 5.1 in in Serbia and North Macedonia, inflation December 2023. By December 2023, inflation expectations have shifted upward. In Kosovo, stood at 7.6 percent in Serbia, 4.3 percent in core inflation picked up in January 2024, Montenegro, 4.0 percent in Albania, 3.6 percent reaching 3.7 percent and remaining almost in North Macedonia, 2.3 percent in Kosovo 2 percentage points above headline inflation. and 2.2 percent in Bosnia and Herzegovina (Figure 6.2). Looking at the past year, inflation Central banks in the WB6 region continued remained above the regional WB6 average of to tighten monetary policy, reflecting 9.3 percent in Serbia (12.5 percent) and North different degrees of exchange rate policy Macedonia (9.4 percent). One significant (Figure 6.5 and 6.6). The National Bank  contributor to the reduction in the CPI was of Serbia responded to high inflation by the deceleration in international commodity continuously increasing the key policy rate prices (see Box 6.1), including food prices, between April 2022 and July 2023. Likewise, which represent a larger share of the CPI basket in North Macedonia, continuing monetary in the WB6 economies compared with the EU policy tightening through September 2023 average,13 and are a key determinant of inflation responded to still-high inflation expectations. in the WB6. These global trends were reflected In Albania, the last monetary policy increase in lower import prices in several countries, such was in November 2023, with policy tightening as Kosovo and Albania. reassuming, despite currency appreciation. While central banks consistently increased Domestic pressures from wages and policy rates, in real terms they nonetheless production costs remain elevated, as remained negative throughout the year. With indicated by the persistently high core inflation expectation persistently high, central inflation. In December 2023, core inflation for banks have further scope for policy tightening, the WB6 remained high, at 5.3 percent, slightly but need to adequately address risks to exceeding headline inflation, even though it banking assets quality. In countries with some has been on a declining trend, since its peak of exchange rate flexibility, currencies in the WB6 9.6 percent in February 2023 (Figure 6.3). Core experienced appreciation pressures supported 13 The simple average of the weight of food in the CPI basket for the region is around 42 percent (IMF, 2023). 26 6. Price increases have eased substantially, but inflationary pressures remain elevated INVIGORATING GROWTH Figure 6.1. WB6 consumer inflation was on Figure 6.2. …reflecting heterogeneity a downward trend in 2023… among countries CPI inflation in WB6 yoy, percent 24 20 20 16 16 12 12 8 8 4 4 0 0 -4 M 20 Se 0 Ja 0 M 21 Se 1 Ja 1 M 2 Se 2 Ja 2 M 23 Se 3 Ja 3 24 M 20 Se 0 Ja 0 M 21 Se 1 Ja 1 M 22 Se 2 Ja 2 M 3 Se 3 Ja 3 24 -2 2 -2 2 2 -2 2 -2 2 -2 2 2 -2 2 -2 2 -2 2 n- p- n- p- n- p- n- p- n- p- n- p- n- n- n- p- n- p- ay ay ay ay ay ay ay ay Ja Ja ▬ CPI inflation ▬ Energy CPI inflation ▬ Food CPI inflation J WB6 ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB Source: National statistical offices and World Bank staff calculations. Figure 6.3. WB6 core inflation has Figure 6.4. The persistence of core remained persistently high, although inflation is observed in all WB6 countries trending downwards through 2023 Percent Core inflation, percent 16 14 14 12 12 10 8 10 6 8 4 6 2 4 0 2 -2 0 -4 Se -19 M 20 Se 0 Ja 0 M 21 Se 1 Ja 1 M 2 Se 2 Ja 2 M 23 Se 3 Ja 3 24 M -19 Ja 19 M 20 Se -20 Ja 20 M -21 Se -21 Ja 21 M 22 Se -22 Ja 22 M 23 Se -23 Ja 23 24 -2 2 2 -2 2 -2 2 -2 2 n- p- p- p- n- p- n- p- n- p- n- p- n- n- n- p- n- p- ay ay n ay ay ay n ay ay ay ay Ja Ja ▬ CPI inflation ▬ WB6 core inflation ▬ ALB ▬ BiH ▬ KOS  MKD ▬ MNE ▬ SRB ▬ WB6 Source: National statistical offices and World Bank staff calculations. Source: National statistical offices and World Bank staff calculations. Figure 6.5. Central banks tightened Figure 6.6. Amid currency appreciation monetary policy in response to persistent pressures, central banks allowed for inflation expectations different degree of exchange rate flexibility Policy rates, percent Exchange rate annual changes, percent 10 2 9 0 8 7 -2 6 -4 5 4 -6 3 -8 2 -10 1 0 -12 14 15 16 17 18 19 20 21 22 23 24 Se -19 De -19 ar 9 Ju -20 Se -20 De -20 M -20 Ju -21 Se -21 De -21 ar 1 Ju -22 Se -22 De -22 M c-22 Ju -23 Se -23 De -23 23 M c-2 M c-1 n- n- n- n- n- n- n- n- n- c- n- n- ar n p n p n p n p ar c n p Ja Ja Ja Ja Ja Ju Ja Ja Ja Ja Ja Ja ▬ ALB ▬ MKD ▬ SRB ▬ ALB ▬ MKD ▬ SRB Source: Central banks and World Bank staff calculations. 6. Price increases have eased substantially, but inflationary pressures remain elevated 27 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 by high inflows of FDI and exports. The central banks of Serbia and North Macedonia (de facto) stabilized their exchange rates, while the Bank of Albania allowed for flexibility, with the Albanian lek appreciating by 9 percent yoy by December 2023. Box 6.1. During 2023, inflation started to slow across the globe, raising hopes of a further easing of inflationary pressures into 2024 Despite the decline in the rates of inflation seen in 2023, both headline and core inflation remained elevated and above target in many inflation-targeting economies (Figures 6.7 and 6.8). Global median headline inflation stood at 8.4 percent in January 2023,  and gradually declined to 3.9 in December 2023. During 2023, inflation declined more prominently in advanced economies rather than emerging market and developing economies (EMDEs) where, on average, price pressures remained more elevated. Key drivers of lower inflation at the global level have been moderating commodity prices, as well as slowing consumer demand. In global markets, the average price of most commodities fell during 2023. However, they remained more than 40 percent above their pre-pandemic levels. The commodity price index fell by 24 percent in 2023, mostly due to decelerating energy prices. Crude oil prices averaged US$83/bbl in 2023, down from US$100/bbl in 2022. Consumer food price inflation, measured as yoy change in the food component of a country’s CPI, eased in 2023, reflecting a more ample supply of major crops, but it remained elevated across the globe.14 Figure 6.7. Inflation slowed across the Figure 6.8. …but remains above target globe in 2023… in many inflation-targeting economies Median headline global inflation Share of countries with inflation above target 12 120 10 100 8 80 6 60 4 40 2 20 0 0 Ap 1 21 O 1 Ja 1 Ap 2 22 O 2 Ja 2 Ap 3 23 O 3 Ja 3 24 Se -19 De -19 ar 9 Se -20 De -20 M -20 Ju -21 Se -21 De -21 ar 1 Ju -22 Se -22 De -22 ar 2 Ju -23 Se -23 De -23 23 Ju -20 2 l-2 -2 2 l-2 -2 2 l-2 -2 M c-2 M c-2 M c-1 r- n- n- r- n- r- n- c- ct ct ct n p n p ar Ju n p n p Ju Ju c n p Ja Ju ▬ Global ▬ Advanced economies ▬ Advanced economies ▬ EMDEs ▬ EMDEs ▬ 2015–2019 average Source: World Bank Global Economic Prospects. 14 Information from the latest month between October 2023 and January 2024 for which food price inflation data are available shows high inflation in many low and middle-income countries, with inflation higher than 5 percent in 57.9 percent of low-income countries, 71.7 percent of lower-middle-income countries, 48.0 percent of upper-middle-income countries, and 45.5 percent of high-income countries. 28 6. Price increases have eased substantially, but inflationary pressures remain elevated INVIGORATING GROWTH (Box 6.1 continued) The decline in inflation proceeded under markedly different growth conditions across countries. In some economies such as the United States, easing price pressures occurred together with resilient economic activity, while in others (e.g., the Euro area) the decline in the rate of price rises was accompanied by weaker economic growth. The sharp tightening of monetary policy and financing conditions played an important role in bringing down inflation in many advanced economies (AEs) and EMDEs. At the global level, in 2023, wage growth generally remained contained and wage-price spirals have not become a key driver of inflation. The trend of demand shift from goods to services continued, as reflected in a decline of goods inflation and more persistent services inflation. As a result of these trends, median core inflation also decreased—from 6.3 percent in January to 3.9 percent in December 2023—but remained persistent, especially in EMDEs where core inflation stood at 4.3 percent by December 2023. 6. Price increases have eased substantially, but inflationary pressures remain elevated 29 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 7. The financial system has maintained resilience while navigating sustained risks The financial sector in the Western Balkans growth decreased most in Albania and Serbia, continued to show resilience throughout dipping to 1.0 and 0.3 percent, respectively, in 2023, despite heightened geopolitical risks, November 2023, before starting to recover in compounded by inflationary pressures and December. Credit growth remained strong in high interest rates. Asset quality improved Kosovo despite slowing down to 12.7 percent slightly, with non-performing loans (NPLs) in December 2023 from 16.0 percent at the reaching a new record low, at 3.8 percent of beginning of the year, while only in Bosnia total loans, while profitability increased and and Herzegovina did the average credit growth capital buffers strengthened. increase in the second half of the year. Credit growth was slow in 2023, at below Corporate loan growth continued to be 6 percent in the second half of 2023, amid significantly lower than household loan tightening credit supply conditions. Average growth throughout the year. Regional credit growth was below 6 percent in the average growth for corporate loans declined second half of 2023, with the exception of a to 1.0 percent in October 2023, and almost slight uptick to 6.5 percent in December 2023. stalled in Albania and Serbia, indicating Although there was no major deterioration that banks tightened standards more for in household and corporate balance sheets in small and medium enterprises (SMEs) and 2023, tightening of credit supply and financing corporate clients (Figure 7.2). SMEs may be conditions placed additional strain on borrowers particularly vulnerable to tightening credit in need of financing, ultimately exacerbating supply conditions, higher financing costs, credit risk and the likelihood of default. Credit and a slowdown in economic activity, while Figure 7.1. Sluggish credit growth Figure 7.2. Weakening corporate loan dominated H2 2023, particularly in growth dipped to 1 percent in October Albania and Serbia before bottoming out Change in nonfinancial private sector credit outstanding, percent, Change in credit outstanding, January 2024, percent, yoy yoy 20 20 15 15 10 10 5 5 0 0 -5 23 16 17 18 19 20 21 22 23 -5 c- n- n- n- n- n- n- n- n- De Ja Ja Ja Ja Ja ALB BiH KOS MKD MNE SRB Ja Ja Ja ▬ ALB ▬ BiH ▬ MKD ▬ MNE ▬ SRB ▬ KOS J Firms J Households Sources: IMF International Financial Statistics; central banks. Source: Central banks. 30 7. The financial system has maintained resilience while navigating sustained risks INVIGORATING GROWTH households’ real incomes and consumption Improvements in the asset quality of banks remained under pressure due to the higher decelerated during 2023, particularly in cost-of-living expenses. WB6 countries with stagnating credit growth. The WB6 average NPL ratio only The mismatch between credit demand slightly improved by 0.1 of a percentage point and supply is expected to narrow in H1 to 3.8 percent, largely remaining flat during 2024. According to the results of the latest 2023 (Figure 7.3). The improvement in asset Central, Eastern and Southeastern Europe quality slowed down mostly in countries with (CESEE) Bank Lending Survey,15 credit low credit growth, such as Serbia and Albania. demand remained robust during the second The NPL ratios were higher than the region’s half of 2023, albeit on a gradual declining average in Montenegro (5.9 percent), Albania trend since April 2021. Fixed investments (5.2 percent) and Bosnia and Herzegovina and retail components, especially related to (4 percent). As of September 2023, the the housing market, contributed negatively to NPL ratio increased slightly in Albania and credit demand growth, while the key driving Serbia compared with December 2022, while factors remained corporate liquidity needs declining or remaining stable in the other WB6 for inventories and working capital, as well countries, with the lowest level in Kosovo at as debt restructuring. Credit needs for fixed 2 percent. investments are expected to resume in the coming months, especially for large corporates, Overall, asset quality remained resilient, while retail segments are expected to remain despite persisting concerns about the weak. Credit supply conditions are expected to medium-term economic outlook. Sustained deteriorate again over H1 2024, motivated by high interest rates, ongoing inflation, and a weak market outlooks, but are gradually moving deteriorating economic outlook, along with toward a more neutral situation. Tighter supply slowing credit, are expected to put further conditions are expected to further impact all pressure on the financial sector’s vulnerabilities, business segments, with the highest impact including those related to highly leveraged on SMEs. Looking forward, despite persistent borrowers, real estate markets, floating rates tightening, cross-border banking groups do not loans, and unsecured consumer lending. foresee a significant deleveraging or strategic The widening gap between stage 2 and stage change in the region over H1 2024. Positive 3 loans16 is clear evidence of existing and funding conditions driven by corporate and potentially growing pressures on credit risk. retail deposits are expected to continue while As of December 2022, the WB6 average for central bank funding continues to decline in stage 2 loans was at 11.82 percent of total H1 2024. loans, much higher than the NPLs ratio, at 3.9 percent. Meanwhile, stage 2 loans have been increasing consistently in the post- pandemic environment. The CESEE Bank 15 EIB Central, Eastern and Southeastern Europe Bank Lending Survey, Fall 2023 (H2). 16 Stage 2 Assets, in the context of International Financial Reporting Standard (IFRS) 9, are financial instruments that have deteriorated significantly in credit quality since initial recognition but that offer no objective evidence of a credit loss event. Assets are classified stage 3 if the loan’s credit risk increases to the point where it is considered credit impaired. The IFRS is published by the International Accounting Standards Board. IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy and sell nonfinancial items. 7. The financial system has maintained resilience while navigating sustained risks 31 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Figure 7.3. Asset quality improvements Figure 7.4. Banks’ capital buffers slowed down, with NPL ratios almost flat strengthened in 2023 NPLs as a percentage of total loans, September 2023 Percent, September 2023 7 25 6 20 5 4 15 3 10 2 5 1 0 0 MNE ALB BiH SRB MKD KOS WB6 SRB MNE ALB BiH MKD KOS WB6 J Dec-22 J Mar-23 J Jun-23 J Sep-23 J Dec-22 J Mar-23 J Jun-23 J Sep-23 Sources: IMF Financial Soundness Indicators; central banks. Sources: IMF Financial Soundness Indicators; central banks. Lending Survey also indicates that, given the by rising interest rates boosting net interest unfavorable economic outlook, banks expect margins. As of September 2023, Kosovo, that NPLs will increase further during 2024.17 Montenegro, and Serbia had the highest profitability (2.6 percent), while Albania had Capital buffers in the Western Balkan the lowest (1.9 percent). While higher rates countries continued to strengthen, thanks may support net interest margins on new bank to higher profitability and low NPLs, while loans, history has shown that credit exposures liquidity remained broadly stable in 2023. can deteriorate rapidly, and loan demand can As of September 2023, the bank capital collapse when an economy enters a recession, adequacy ratio averaged 19.3 percent, far above affecting bank profitability. the regulatory minimum, and higher compared with December 2022, at 18.3 percent (Figure Nevertheless, the uncertain economic 7.4). The ratio of liquid to total assets averaged backdrop continues to raise concerns about 29.6 percent in September 2023, with the the medium-term outlook. With inflation still lowest in North Macedonia (18.9 percent) high in many countries, major central banks and the highest in Serbia (40 percent). Loan- are determined to keep interest rates higher for to-deposit ratios were well below 100 percent longer than priced in by markets. The high- across the board (74.7 percent on average interest environment, which is now expected in September 2023), indicating slower loan to last longer than previously anticipated, is growth than deposit growth. triggering asset repricing, changing investor sentiment, and altering asset allocations. In Higher interest rates helped boost banks’ recent years, firms and households have managed lending margin and profitability. Profitability, to shore up their balance sheets with the help as measured by return on assets, increased of government support programs, pandemic to 2.4 percent in September 2023 from savings, and restructurings. However, weaker 1.7 percent a year before, supported mainly growth expectations, slowing credit growth, 17 Central, Eastern and Southeastern Europe (CESEE) Bank Lending Survey, Fall 2023. 32 7. The financial system has maintained resilience while navigating sustained risks INVIGORATING GROWTH and the extended duration of pressures from insurance sector is also crucial in strengthening higher interest rates and costs of living may financial stability. Insurance companies enable strain the debt-servicing capacity of borrowers. economic agents to diversify distinctive risk, In particular, firms with low cash-to-interest- thereby supplying the necessary preconditions expense ratios and mortgage borrowers will for certain business activities. Insurance continue to face a higher repayment burden. companies are a major source of long-term risk capital to the real economy and are among the Incidents over the past year involving largest institutional investors. Their long-term United States regional banks and a globally investment horizon can in principle enable systematically important bank in the EU, them to act as a shock absorber in financial showed the importance of being vigilant markets. Insurers have longer-term liabilities and addressing vulnerabilities. To capture than banks, greater diversification of assets, and any brewing vulnerability, and to respond less extensive interconnections with the rest of adequately and in a timely manner, supervisors the financial system. Despite its critical role in should continue to require banks to be fully financial development and financial stability, prepared for potential declines in asset quality. the insurance sector in the WB6 region is This includes ensuring that banks have robust underdeveloped, offers limited products, and credit risk monitoring and management, requires capacity building with a strengthened appropriate loan classification, accurate loan regulatory and supervisory framework. Almost staging, and adequate loan loss provisioning. all the countries in the region have embarked Regulators and supervisors should maintain in structural reforms to develop their insurance vigilance and closely monitor real-estate sectors, with the aim of aligning with the EU lending (particularly commercial), unsecured standards in the coming years (see Box 7.1). consumer lending, highly leveraged borrowers, and sectors particularly vulnerable to rising inflation. While strengthening financial stability in their bank-dominated economies, WB6 countries should also aim to develop a well- diversified financial system to safeguard stability in the longer term. A well-diversified financial sector should be consisting of a range of consumer and commercially-oriented segments including banking, capital markets, non-bank financial institutions, insurance, and pensions, offering a wide variety of financial products and services. The insurance sector is one of the key pillars of a diversified financial sector and plays a critical role by providing businesses and households with protection against future risk and uncertainty. The 7. The financial system has maintained resilience while navigating sustained risks 33 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Box 7.1. The insurance sector development in the Western Balkans, and Solvency II The insurance sector in the Western Balkan countries constitutes a relatively small proportion of the overall financial sector. On average, banking sector assets range from 62 to over 95 percent of GDP in the WB6; in comparison, the banking sector accounts for about 84 percent of GDP in the EU. In contrast, insurance sector assets range from just 2 to 5 percent of GDP, on average, in the Western Balkans, while in the EU the average is 42 percent. Within the relative limited space, the predominant offering by the sector is in the form of motor vehicle insurance. As a precursor to deepening the insurance sector and improving risk coverage, both the supervisory framework and the capacity of the insurance agencies should be enhanced. Across the region, many insurance companies are characterized by low solvency margins, implying that the ability of some insurance companies to honor claims to the beneficiaries when they occur is weak, which may require supervisory actions. The insurance regulatory agencies in the region are predominantly reliant upon the Solvency I prudential supervisory framework, which is not risk sensitive. Solvency I has minimal capital requirements and does not commensurately weigh risk for the insurance companies, such as market risk faced by the companies. Instead, Solvency II harmonizes asset and liability valuations, and has a wider scope that imposes higher capitalization requirements and allows for better management of risks within the sector. Albeit at varying stages of reform, all Western Balkan insurance regulatory agencies are improving their insurance regulatory framework. It is important to note that Solvency II compliance is a long-lasting process, especially when Western Balkan current capacities are considered. Many countries in the region have initiated efforts in this direction by conducting gap assessments and developing roadmaps: • Albania has developed a Solvency II roadmap and is making plans for its implementation and harmonization with the International Financial Reporting Standards (IFRS) 17 standard. • Bosnia and Herzegovina has conducted a gap assessment regarding IFRS 9 and 17 and Solvency II, and has started to develop a strategy for the implementation of Solvency II. • Kosovo has started to develop a Solvency II roadmap and is contemplating amendments in its insurance regulation. • Montenegro is in the process of modifying its Law on Insurance in accordance with the Solvency II Directive. • North Macedonia’s legislation alignment with the Solvency II Directive remains pending. • Serbia has adopted the Strategy for Implementation of Solvency II, including amendments between 2016 and 2021. 34 7. The financial system has maintained resilience while navigating sustained risks INVIGORATING GROWTH (Box 7.1 continued) The process of modernizing and aligning the insurance sector’s regulatory and supervisory framework is a critical step for the sector’s ability to adequately monitor risks and properly insure against losses. The importance of building a modern insurance sector becomes more evident as financial losses associated with climate and environment risks, such as, floods, earthquakes, droughts, that are facing the Western Balkan countries become more frequent and severe. With a strengthened oversight of the sector, the insurance industry could also play a pivotal role acting as an institutional investor within domestic capital markets. Importantly, the harmonization of the insurance regulatory framework and increased capacity of insurance regulation and supervision would also be an important step toward a single financial service market within the EU. 7. The financial system has maintained resilience while navigating sustained risks 35 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 8. The external position is improving on the back of lower import prices and strong net services exports The WB6 countries witnessed an Across all WB6 countries, both merchandise improvement in their external position exports and imports exhibited a downward during 2023. The current account deficit adjustment, in GDP terms, with imports (CAD) declined from 7.8 percent of GDP declining more than exports largely due to in 2022 to a historic low of 4.9 percent of lower import costs. The WB6 merchandise GDP in 202318, marking the most significant trade deficit amounted to 27 percent of GDP improvement in the past two decades in 2023, a sizable improvement from a deficit (Figure 8.1). While Bosnia and Herzegovina of over 30 percent the year before (Figure experienced a marginal uptick in the external 8.3). This was driven not only by a decline deficit by 0.4 of a percentage point to reach in import prices, but also by import volumes, 4.7 percent of GDP in 2023, all other countries rather than higher exports (except in Serbia). in the region exhibited improvements in their The region witnessed a reduction in demand external balances. Two countries experienced for exports due to weaker EU growth. This the most significant downward adjustment in led to a simultaneous decline in the region’s the external deficit, namely North Macedonia demand for imports of intermediate input. with its second-ever current account surplus The import of consumption goods, however, amounting to 0.7 percent of GDP in 2023, and remained robust due to private consumption Serbia, with a compression of 4.3 percentage contributing most to real GDP growth in most points to a current account deficit of 2.6 percent countries in the region. of GDP in 2023—a return to normal, after a one-off increase in CAD in 2022 due to the domestic energy crisis (Figure 8.2). Figure 8.1. The regional current account Figure 8.2. …with North Macedonia and deficit keeps improving… Serbia accounting for largest share of the external adjustment Percent of GDP Percent of GDP MNE KOS BiH ALB SRB MKD WB6 12 -5 0 8 -5 4 -10 -15 0 -20 -4 -25 -30 -8 -35 -12 -40 BiH MNE ALB KOS SRB MKD J 2007 J 2009 J 2020 J 2022 J 2023 J Goods exports J Goods imports J Net services exports J Remittances J Others Q Change in CA deficit Source: Central banks, World Bank staff calculations. 18 These are simple averages across the WB6 countries. 36 8. THE EXTERNAL POSITION IS IMPROVING ON THE BACK OF LOWER IMPORT PRICES AND STRONG NET SERVICES EXPORTS INVIGORATING GROWTH Figure 8.3. The merchandise trade deficit Figure 8.4. …and remittances remain has returned to the long-term average, robust, while net services exports after the deterioration in 2020… maintain record highs reached in 2022 Percent of GDP Percent of GDP KOS MNE BiH ALB MKD SRB WB6 12 0 11 -10 10 -20 9 8 -30 7 -40 6 5 -50 4 10 20 1 20 2 20 3 20 4 20 5 16 20 7 18 20 9 20 7 08 20 9 20 20 1 22 23 1 2 1 0 1 1 1 1 1 0 20 20 20 20 -60 20 20 20 J 2007 J 2009 J 2020 J 2022 J 2023 ▬ Remittances ▬ Net services exports Source: Central banks, World Bank staff calculations. Two trade stories stand out in 2023—North of net service exports. The regional increase Macedonia and Serbia. In North Macedonia, in net service exports was mostly due to an stagnant export growth and declining acceleration in tourism receipts in Montenegro imports led to a significant contraction in the by 4.3 percentage points of GDP in 2023 merchandise trade deficit, which shrunk by compared with the previous year. Meanwhile, an impressive 8 percentage points to close to Kosovo’s diaspora helped increase net services 18.9 percent of GDP. Despite an increase in by 1.1 percentage points to 16.5 percent of GDP food, machinery and transport imports, total in 2023. In Albania, robust service exports, merchandise imports declined nominally by bolstered the current account and caused in 8 percent in 2023 primarily driven by a sharp part the appreciation of the Albanian lek. As a 60 percent compression in electricity imports result, the first three quarters of 2023 marked and a 23 percent decline in petroleum products the first surplus in the current account balance compared with the previous year. In Serbia, in Albania since 2008. The stronger Albanian meanwhile, imports declined by 5.6 percent, lek, however, hurt the competitiveness of goods while export of goods increased by 3.3 percent exports, resulting in a 9.3 percent decline. In (in euro terms). As a result, the merchandise the case of Serbia, the key contributor to the trade deficit narrowed from 15 to 10 percent of positive net services export balance was a fast- GDP, with the import of goods declining due growing IT sector. Net exports of IT services to lower petroleum product imports, chemicals, reached about 3.8 percent of GDP in 2023. and manufactured goods. Remittances rose but more slowly than Robust net services exports contributed regional GDP. Therefore, despite growing to the improvement in the CAD in WB6 by an estimated €230 million, in GDP terms countries in 2023. Net service exports net remittances decelerated to 6.5 percent remained in 2023 at a record-high level, staying in 2023 from 7 percent of GDP the year close to 11.5 percent of GDP, as observed in before. This is still 0.3 pp of GDP higher than 2022 (Figure 8.4). Net tourism receipts and the five-year average prior to the pandemic. diaspora travels home accounted for the bulk Remittances grew most in Kosovo, with an 8. THE EXTERNAL POSITION IS IMPROVING ON THE BACK OF LOWER IMPORT PRICES AND STRONG NET SERVICES EXPORTS 37 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Figure 8.5. At the regional level, FDI Figure 8.6. Total external debt continued inflows fully finance the CAD, but country its decline in 2023, reaching 71.3 percent differences are significant of GDP Percent of GDP Percent of GDP 12 250 10 200 8 150 6 100 4 50 2 0 2010 2015 2010 2015 2010 2015 2010 2015 2010 2015 2010 2015 2010 2015 2020 2022 2023 2020 2022 2020 2023 2022 2020 2023 2022 2020 2020 2023 2022 2022 2020 2023 2023 2022 2023 0 ALB KOS MNE SRB MKD BiH WB6 MNE ALB MKD SRB BiH KOS WB6 J CAD J Net FDI J Public J Private Source: Central banks, World Bank staff calculations. Source: Central banks, World Bank staff calculations. estimated increase of €149 million. Albania the lowest level of inflows in the region and Bosnia and Herzegovina averaged together estimated at 2.9 percent of GDP, half the about €50 million. In Montenegro remittances average of the remaining five countries in the inflows declined by 11 percent, while North region. In sum, net FDI inflows exceeded the Macedonia and Serbia exhibited a small decline. CAD in Albania, Serbia, and North Macedonia and, at the regional level, more than offset the The CAD at the WB6 regional level is financing gaps in the other three countries almost entirely financed by net FDI inflows (Figure 8.5). (Figure 8.5). Net FDI inflows amounted to  5.4 percent of GDP in 2023, or 0.5 pp of GDP Total external debt continued its decline higher than the external deficit. These inflows in 2023, reaching 71.3 percent of GDP, a were predominantly equity investments and significant drop of almost 17 pp from its reinvestments, with a smaller proportion in peak in 2020(Figure 8.6). This decline was inter-company loans. Even in Serbia, where evenly distributed regionally, with both public traditionally inter-company loans play a and private external debt decreasing by about 8 greater role, in 2023 equity investment and and 9 pp respectively in 2023 compared with reinvested earnings accounted for €3.5 billion the peak observed in 2020. External public debt of inflows compared with €1.0 billion in declined in Albania, Bosnia and Herzegovina, intercompany loans. Consequently, non-debt and Montenegro, in GDP terms, in line with creating financing played a dominant role in the general decline in total public debt and the structure of net FDI inflows in the Western higher GDP. In Albania, external public debt Balkans. Albania led with the highest net FDI declined in 2023 by about 0.6 percent of GDP. inflows at 6.8 percent of GDP, closely followed Serbia witnessed an increase in external public by Kosovo at 6.4 percent and Montenegro at debt of close to 1 percent of GDP, which fully 6.3 percent. The high sovereign risk premium, accounts for the increase in total public debt among others, continues to weigh on FDI from 35.7 percent in 2022 to 36.5 percent inflows in Bosnia and Herzegovina. In 2023, in 2023. In North Macedonia and Kosovo, Bosnia and Herzegovina continued to exhibit external public debt increased by 0.4 and 38 8. THE EXTERNAL POSITION IS IMPROVING ON THE BACK OF LOWER IMPORT PRICES AND STRONG NET SERVICES EXPORTS INVIGORATING GROWTH 0.1 pp of GDP, respectively. Meanwhile, private external debt fell to 39.6 percent of GDP in 2023 at the regional level. Most countries in the region witnessed a build-up in foreign exchange reserves in 2023. In Serbia, foreign exchange reserves reached a record high of €4.9 billion by the end of 2023, with similar impressive increases observed in North Macedonia, Albania, and Bosnia and Herzegovina. Montenegro, in contrast, experienced a decline in foreign exchange reserves due to larger repayments of external debt and somewhat stronger portfolio outflows. 8. THE EXTERNAL POSITION IS IMPROVING ON THE BACK OF LOWER IMPORT PRICES AND STRONG NET SERVICES EXPORTS 39 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 9. The outlook improved, but growth remains too low for faster convergence with the EU While the 2023 economic performance for 3.5 and 3.8 percent in 2025 and 2026 (Table the WB6 region as whole turned out to be 9.1). Kosovo and Serbia are expected to drive in line with previous projections, there regional growth over the medium term, while was some reshuffling among countries. the other four countries will grow at below the Montenegro and Serbia were the only countries regional average. Growth in these two countries that performed better than previously projected, is expected to be driven by consumption and while other countries underperformed resilient services exports. At the other end of the compared with the previous set of projections. spectrum, consumption is expected to increase Serbia’s growth turned out to be stronger in Albania and Bosnia and Herzegovina only than originally projected (2.5 compared with gradually, insufficient to contribute significantly originally projected 2.0 percent growth in to growth. In Montenegro, coming from a very 2023), thanks to a recovery of the agriculture high base, growth is expected to moderate to and construction sectors in the second half of a still relatively strong 3.4 percent in 2024, the year. Montenegro’s 2023 growth estimate is supported by tourism and private consumption. higher by 1.2 pp compared with that originally In North Macedonia, looming elections and projected, thanks to a strong tourism season. slow progress with structural reforms will keep The remaining four countries had lower 2023 growth at a relatively low level. GDP growth than previously projected. As a result of these developments, overall growth in With currently projected growth rates, the the WB6 region is estimated at 2.6 percent, in WB6 region is expected to return to its line with previous projections. pre-pandemic trend in 2024, though this is insufficient to enable convergence with Projections for the medium term (2024– EU income levels over the medium term. 26) increased slightly, compared with the While growth rates for individual countries are previous round of projections. Regional expected to be between 2.5 and 4.0 percent over GDP growth for the WB6 is expected to the projection period, thus leading to average increase to 3.2 percent in 2024 and further to regional growth above the pre-pandemic trend, Table 9.1. Real GDP growth 2023e 2024f 2025f 2026f Albania 3.3 3.3 3.4 3.5 Bosnia and Herzegovina 1.9 2.6 3.3 4.0 Kosovo 3.1 3.7 3.9 3.9 North Macedonia 1.0 2.5 2.9 3.0 Montenegro 6.0 3.4 2.8 3.0 Serbia 2.5 3.5 3.8 4.0 WB6 2.6 3.2 3.5 3.8 Source: World Bank staff projections. 40 9. The outlook improved, but growth remains too low for faster convergence with the EU INVIGORATING GROWTH Figure 9.1. With currently projected Figure 9.2. Measured in PPP terms, growth rates, the WB6 region is expected GDP per capita in the Western Balkans to return on its pre-pandemic trend in remains at almost 40 percent of the EU 2024 average Real GDP actual and projected 2024–25 GDP per capita, PPP (constant 2017 international $) - WB6 average as a share of EU average 150 40 140 130 35 120 110 30 100 90 25 10 11 12 13 14 15 16 17 18 19 08 09 20 21 22 20 20 20 20 20 20 20 20 20 20 20 20 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 20 20 20 ▬ WB6, actual ▬ WB6 projection based on pre-COVID trend Source: World Bank staff calculations based on data from national Source: WDI, World Bank staff calculations. statistical offices. Note: WB6 is simple average. Note: Based on (i) current projections, and (ii) trend 2012–2019. this is insufficient to provide faster convergence Figure 9.3. The global economy is expected to face the weakest half-decade with the EU in terms of income per capita. growth since 1995 Measured in PPP terms, GDP per capita in the Global real GDP growth, percent Western Balkans remains at almost 40 percent 3.5 3.3 3.2 3.2 3.0 of the EU average (Figure 9.2). 3.0 2.6 2.5 2.2 2.1 Risks to the outlook are tilted to the 2.0 downside. First, global growth will be 1.5 1.0 slower than expected (see Box 9.1). A global 0.5 slowdown in 2024, for the third consecutive 0 year, will be caused mainly by the slowdown 4 9 4 9 4 9 4 –9 –9 –0 –0 –1 –1 –2 10 15 20 among advanced economies. This means that 90 95 00 05 20 20 20 19 19 20 20 the global economy will face the weakest half- Source: World Bank, GEP, January 2024. decade growth since 1995 (Figure 9.3). A prolonged slowdown in the EU is particularly risks emanate from public-private partnerships worrying since it will translate into weaker and SOEs, in addition to the country’s investment and trade with the WB6.19 Second, hydropower-based energy sector, mainly due there are domestic factors that put the baseline to variation in hydrology. In Montenegro, set of projections at risk: outward migration the high cost of external financing poses a (could be in particular worrying in Kosovo); risk given the country’s substantial financing elections (in North Macedonia and Serbia), needs. Additional risks to growth for the WB6 and elevated inflation for longer period in countries emanate from natural disasters and some of the WB6 countries. In Albania, fiscal climate change. 19 For the WB6 region, the most important is another round of downward revisions for growth in the Euro area (a cut of 0.6 pp in 2024) by the GEP January 2024 edition. 9. The outlook improved, but growth remains too low for faster convergence with the EU 41 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Box 9.1. This year will continue to be challenging, before brighter horizons appear in 2025–2026 In 2023, global growth reached 2.6 percent but is expected to decelerate in 2024, before picking up again in 2025–2026. The disparity in economic resilience in advanced economies—with the United States’ sustaining robustness vis-à-vis the Euro area’s weakness—is projected to persist during 2024. China’s economic momentum is anticipated to further decelerate, on the back of the real estate sector downturn, which will weigh on the outlook for EMDEs. Global trade is expected to pick up in 2024 after reaching a standstill in 2023, boosted by increased goods demand while services trade growth stabilizes near pre- pandemic levels. However, the trade outlook is expected to remain subdued, weighed down by proliferating trade-restrictive measures, among other factors. The Sentix Global Economic Index suggests an uptick in global activity starting in Q1 2024, with recent positive revisions in consensus forecasts now projecting a modest global growth rate of 2.4 percent for 2024 (Figure 9.4a). Inflation rates are on a downward trajectory, progressing toward their target levels. In February 2024, the median global headline inflation was recorded at 3.3 percent, with EMDEs’ inflation higher at 4.0 percent (Figure 9.4b). Core inflation numbers are close to the headline numbers. Inflation significantly dropped in 2023, but remains over target in many AEs and about half of EMDE countries (Figure 9.4b). With major AEs on the brink of loosening monetary policies and most EMDEs already in the process of monetary easing, inflationary pressures are anticipated to ease further. More subdued global demand and marginally reduced commodities prices are expected to facilitate a further decrease in inflation in 2024–25. Following a lackluster performance in 2023, euro area growth is expected to rebound in 2024. Growth slowed to just 0.4 percent in 2023, affected by tight credit conditions, low exports, and elevated energy costs. Recent high-frequency indicators, including composite and manufacturing Purchasing Managers Index (PMI) data, signal a relative improvement in the activity for Q1 2024, while remaining in contractionary territory (Figure 9.4c). While growth for 2024 is expected to remain tempered by the continuation of tight monetary policy, the outlook for 2025–26 is expected to improve, as export and investment growth gains momentum, driven by a relaxation of monetary policy constraints and the effective deployment of EU funds. The Western Balkans’ trade trajectory will continue to be strongly influenced by the euro area region, as it remains the primary destination for their exports. Downside risks to the baseline projections continue to dominate the outlook, notably due to geopolitical tensions. Russia’s invasion of Ukraine is still ongoing after more than two years and shows no signs of abating. An escalation of that conflict, or the conflict in the Middle East, could increase commodity prices. While inflationary pressures and financial 42 9. The outlook improved, but growth remains too low for faster convergence with the EU INVIGORATING GROWTH (Box 9.1 continued) stress may have eased, global financial conditions could tighten. In the ECA region, numerous upcoming elections will amplify political uncertainty regarding economic policy direction. Moreover, increasing trade fragmentation could lead to higher trade costs and have adverse global repercussions. In 2023, nearly 4,000 new detrimental trade interventions were implemented globally (Figure 9.4d). The trade implications hold significant importance for the WB6, given the average high degree of trade openness at 123 percent in 2022. Figure 9.4. Global economic developments a. Global growth b. EMDEs inflation Percent Index, 0+ = optimism Index Percent 3.0 8 80 12 2.5 4 60 10 2.0 0 40 8 1.5 -4 20 6 1.0 -8 0 4 0.5 -12 -20 2 0 -16 -40 0 Oc -23 No t-23 De -23 Ja -23 Fe 24 4 Fe -23 M -23 Ap -23 M r-23 Ju -23 Ju 23 Au -23 Se -23 M -24 Ap 21 Ju 1 Oc 21 Ja 21 Ap 22 Ju 2 Oc 2 Ja 2 Ap 3 Ju 3 Oc 3 Ja 3 24 -2 2 2 l-2 2 2 2 l-2 2 n- n- n- r- l- t- n- r- t- n- r- t- n- c ay g n b ar l p v ar b Ja Ja J Consensus forecast ▬ Sentix expectations (rhs) Inflation surprise index for ▬  ▬ EMDEs headline inflation (rhs) EMDEs c. Euro area activity d. Global trade measures Index, 50+ = expansion Percent (3mma) Number of new interventions 58 3.0 8,000 7,000 54 1.5 6,000 5,000 50 0 4,000 3,000 46 -1.5 2,000 1,000 42 -3.0 0 2 No 2 22 M 3 M 3 3 Se 3 No 3 23 b- 4 24 l-2 2 2 -2 -2 l-2 2 Fen-2 p- v- n- p- v- 10 20 1 12 20 3 14 20 5 16 20 7 20 8 20 9 20 9 20 20 1 20 2 23 ay ar 1 2 1 1 1 2 1 0 1 Ju Ju 20 20 20 20 20 Se Ja Ja 20 J Industrial production ▬ Manufacturing PMI (rhs) J Harmful J Liberalising ▬ All ▬ Composite PMI (rhs) Source: Consensus Economies; Global Trade Alert; Haver Analytics; World Bank. Note: EMDEs = emerging market and developing economies; 3mma = 3-month moving average. a. Bars show the historical consensus forecast estimates for GDP growth. Red line shows the Sentix Index that reflects perceptions about the global economic outlook, based on investor surveys. Values above zero indicate “optimism” while those below zero indicate “pessimism”. Last survey and observation are March 2024. b. Red line shows the median headline CPI inflation for EMDEs (yoy). Blue line shows the Citigroup Inflation Surprise Index for emerging markets. Values above zero indicate that inflation data are exceeding expectations, EMDE inflation is median annual inflation. Last observations are February 2024. c. Blue line shows the monthly Manufacturing PMI index. Red line shows the monthly Composite PMI. Last observation is February 2024 Yellow bars show the moving 3-month growth rate of industrial production. Last observation is January 2024. d. Bars show the number of new trade interventions per year. Last observation is 2023, based on March 25th, 2024 data. 9. The outlook improved, but growth remains too low for faster convergence with the EU 43 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 But there are some new opportunities that region. Second, diversification in production the WB6 region could seize. First, the EU and exports that has occurred in recent years introduced the new Growth Plan in late 2023 in most of the countries from the region can (see Box 9.2). This is a powerful tool to promote enable them to become part of global value reforms and help to build missing infrastructure. chains and benefit from faster growth in other Both are critical for faster growth in the WB6 parts of the global economy. Box 9.2. The EU’s new Growth Plan for the Western Balkans offers the promise of faster convergence with EU living standards, if opportunities are grasped As small economies, the path of the six Western Balkan economies toward higher income, improved living standards and convergence with the EU depends on economic integration within the region, and between the region and the EU. The region’s small and fragmented markets cannot exploit economies of scale and agglomeration forces alone, and policies that promote economic integration help pool resources for a more attractive and competitive economic environment. The EU is the largest trading partner for the WB6, with over 80 percent of their exports going to the EU and 60 percent of imports coming from the EU. The announcement in November 2023 of the EU’s new Growth Plan for the Western Balkans has provided renewed impetus behind the regional integration agenda, w  ith a mixture of financing and support for reforms aimed at enhancing economic integration with the EU’s single market, as well as boosting economic integration within the Western Balkans through the Common Regional Market based on EU rules and standards. A total of €6 billion in new EU financing is attached to the new Growth Plan over the 2024–27 period, with half to support infrastructure investments and half to be provided as budget support in line with reform actions by the six countries. However, the impact of reforms, coupled with increased access to the EU’s single market, will likely generate significantly larger impacts compared with the direct transfer of resources by the EU. Two critical aspects include: (i) improved trade and transport facilitation, including the extension of the “green lanes” piloted during the pandemic for essential goods to cover substantially all trade through the 10 largest EU27-WB6 border crossing points; and (ii) access to the Single Euro Payment Area (SEPA), allowing for fast and low-cost international payments. With faster and more predictable border clearance processes, there are increased opportunities for international trade, investments and job creation. New World Bank research suggests that reducing border clearance times to those seen in the average OECD economy (the current average gap is about 3 hours) would be equivalent to immediately lowering tariffs in the WB6 by around 2 percent. This would, on average, deliver welfare (real 44 9. The outlook improved, but growth remains too low for faster convergence with the EU INVIGORATING GROWTH (Box 9.2 continued) income) increases of 1.5–3.0 percent in the Western Balkans in the medium term as cross- border trade expands. Furthermore, the gains are amplified by coordinated action on trade facilitation, and even further by full frictionless trade. Figure 9.5. Coordinated action to reduce Figure 9.6. Neighboring EU countries border waiting times in the WB6 would also benefit from faster trade in boost income the WB6, especially if it is coupled with investments in connectivity infrastructure Welfare gains and effect on per capita income in WB6 countries: Welfare gains and effect on per capita income in EU27 countries: reducing waiting times at the border by 3 hours WB6-EU27 frictionless trade and improved road infrastructure 3.5 1.6 3.0 1.4 2.5 1.2 1.0 2.0 0.8 1.5 0.6 1.0 0.4 0.5 0.2 0 0 ALB BiH KOS MNE MKD SRB BGR HRV GRC HUN ROU SVN J Independent policies J Cross-country coordination J Frictionless trade J Improved road infrastructure J Cross-country coordination + frictionless trade J Combined scenario Source: Taglioni et al. (2023) The Economic Effects of Market Integration in the Western Balkans, World Bank Policy Research Working Paper No. 10491. https://openknowledge.worldbank.org/handle/10986/39982. Improving trade facilitation in the Western Balkans also generates tangible welfare gains for neighboring countries in the EU, especially those countries that either trade intensely with, or transit through, the WB6. The largest gains are seen in Croatia, Bulgaria, Greece, Hungary, Romania and Slovenia. The impact of frictionless trade between the WB6 and the EU27 results in welfare gains in these neighboring countries of around 0.2–0.3 percent. However, when coupled with an additional scenario of improved primary road infrastructure for better connectivity in the Western Balkans, the benefits of frictionless trade are sharply amplified. In this scenario, the same group of neighboring EU countries sees welfare gains ranging from 0.56 percent in Slovenia to 1.41 percent in Croatia. Access to the Single Euro Payments Area is a fundamental aspect of the EU’s new Growth Plan for the Western Balkans. For domestic financial transactions in the WB6, cash-based services are still dominant even if significantly more expensive than digital options. Cross- border transactions, critical for foreign trade and remittances, are also significantly more expensive for WB6 countries. According to World Bank calculations, costs for micro and small businesses trading between WB6 economies can be as high as six times more than those incurred by their peers in the EU. Furthermore, the cost of sending remittances to the WB6 economies is 6.71 percent of the total transaction amount, far above the global target of 3 percent set by the United Nations (UN). Reducing the cost of payments to the 3 percent of global target would save €500 million annually in fees paid by WB6 residents. Access to 9. The outlook improved, but growth remains too low for faster convergence with the EU 45 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 (Box 9.2 continued) the European TARGET Instant Payment Settlement (TIPS) system as indirect participants, even before becoming EU members, would enable payment service providers to offer fund transfers to their customers in real time and around the clock. The structural reform agenda remains significant, which should be seen as an opportunity and not a burden from the past. Most of the countries from the region still need to deal with remaining state-owned enterprises (SOEs) that are inefficient and create market distortions; with education systems that fail to deliver the skills demanded by (future) markets and below the levels of peer countries in ECA (as measured by the PISA tests); infrastructure that is poorly managed or missing altogether, which raises the costs of doing business and is prone to climate change-related disasters (as it has been apparent in Albania in the case of earthquakes, droughts in Kosovo, North Macedonia and Serbia, and floods in Serbia and North Macedonia, among others). Addressing these problems—SOEs, governance, education and climate change—with comprehensive, sustainable, and adequately funded policy responses would unleash significant growth potential throughout the WB6 region. 46 9. The outlook improved, but growth remains too low for faster convergence with the EU INVIGORATING GROWTH 10. Heatmap: Western Balkans Indicators Western Balkans Indicator Heatmap Color shading: lighter - lower values, darker - higher values ALB BIH KOS MKD MNE SRB Macro-financial management Real GDP growth Q3 23 3.5 1.9 3.0 1.2 6.6 3.6 Inflation* Dec 23 4.0 2.2 2.3 3.6 4.3 7.6 Employment rate 2023 57.2 41.5 35.4 45.4 55.6 50.3 Credit growth Dec 23 5.0 7.2 12.7 5.3 6.9 1.8 NPLs* Q3 23 5.2 4.0 2.0 2.7 5.9 3.2 Inclusive growth Poverty rate* 2022 23.5 – 23.4 18.3 10.3 8.5 GINI index* latest 29.4 33.0 29.0 33.5 36.8 35.0 LFP gender gap* 2023 15.2 23.4 34.0 19.2 12.7 14.1 Unemployment rate* 2023 10.7 13.2 8.8 13.1 13.1 9.4 Youth unemployment rate* 2023 25.7 29.9 16.9 29.4 23.7 25.1 International economic integration Exports 2022 37.4 48.1 38.6 74.0 51.5 62.9 Imports* 2022 47.8 61.9 71.4 94.9 74.4 74.5 CAB 2022 -6.0 -4.3 -10.3 -6.1 -12.9 -6.9 FDI 2022 6.7 3.0 6.3 5.0 13.2 7.2 Remittances 2022 5.5 7.9 13.4 2.7 6.5 6.2 Sustainable growth Fiscal balance 2022 -3.7 0.5 -0.6 -4.4 -4.9 -3.0 Expenditures* 2022 30.5 39.7 28.4 36.5 43.4 46.4 Revenues 2022 26.8 40.2 27.9 32.1 38.6 43.4 Public and publicly guaranteed debt* 2022 65.4 31.5 20.0 59.0 70.9 55.6 Emissions* 2022 1.7 6.1 4.8 3.6 3.7 6.0 * For these indicators, higher values are associated with worse outcomes. Macro-financial management: Notes: Real GDP growth, inflation and credit growth are expressed as year-on-year, employment as a rate and NPLs as percent of total loans. Sources: National statistical offices; central banks; World Bank staff. Inclusive growth: Notes: Poverty rate calculations is based on ECAPOV harmonization using SILC-C data except for KOS where poverty rate calculations is based on ECAPOV; Household Budget Survey (HBS) data. Income measures in the SILC and consumption measures in the HBS are not strictly comparable; Poverty is defined as living on less than $6.85/day per person in revised 2017 PPPs; GINI - 2020 (ALB, SRB), 2019 (MKD), 2018 (MNE), 2017 (KOS), 2011 (BiH). Sources: National statistical offices; World Bank staff. International economic integration: Notes: Indicators are expressed as percent of GDP. Exports and imports refer to exports and imports of goods and services. Sources: National statistical offices; central banks; World Bank staff. Sustainable growth: Notes: Indicators are expressed as percent of GDP, except emissions which are expressed as tonnes per person. Emissions refer to annual total emissions of carbon dioxide (CO₂), excluding land-use change. Sources: National statistical offices; central banks; Global Carbon Budget (2023); Population based on various sources (2023) – with major processing by Our World in Data; World Bank staff. 10. Heatmap: Western Balkans Indicators 47 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 11. Spotlight: Greening Cities 11.1 Cities, growth and green growth— physically, facilitating the exchange of ideas What do we know? and bringing about innovations. These are referred to as agglomeration economies. High Cities as engines of growth population densities also make it cheaper to provide services efficiently and equitably. As Urbanization is both an indicator and a driver a result, many of the benefits of urban life— of development. Fifty-six percent of the world’s productivity and livability—are associated population lives in cities, generating more than with proximity within the city. Capital cities 80 percent of global GDP.20 In 2022, 60 percent in the region have indeed been contributing to of the Western Balkan region’s population, national growth given their high population on average, was urban—15 percentage points concentration and large shares of national lower than the average for the EU.21 Between economic activity (Figure 11.1). 1960 and 1990, urban population growth was rapid, at almost 2 percent a year.22 This has Unfortunately, structural, and demographic implications for national development, given challenges, as well as exposure to climate that cities are where economic development effects, have limited the ability of Western really happens. They allow workers to be closer Balkan cities to drive national growth. to jobs, increasing opportunities and fueling Although the late 20th century came with productivity. They bring people together rapid urban population growth and expansion, Figure 11.1. Capital cities account for a large share of national GDP, population, labor force, jobs, and active enterprises Percent 60 50.4 45.9 50 44.0 38.8 37.5 37.4 40 33.3 33.1 33.2 33.2 32.4 32.2 30.8 30.4 30.0 29.9 29.6 29.0 28.7 26.9 30 24.2 23.9 23.7 23.3 23.2 18.9 16.7 20 14.8 14.5 13.0 11.9 11.9 11.0 10 0 EU Capitals Sarajevo Tirana Pristina Belgrade Skopje Podgorica J Share of national GDP (2015) J Share of national employment (2015) J Share of population (2015) J Share of working age population (2015) J Share of all active enterprises (2016, 2011 for Podgorica) Sources: World Bank, 2019; Eurostat Data Browser; OECD Kosovo Economy Profile 2022. Note: EU capitals calculation based on average of 27 EU country capitals for 2015. Share of all active enterprises: the number of active enterprises for EU capitals shown for 2016 and based on available data for 19 capital cities, for Pristina (Kosovo) shown for 2019; and share of national employment—the number of employed persons for EU capitals calculated for 2017. 20 World Bank. 2023. Urban Development. https://www.worldbank.org/en/topic/urbandevelopment/overview. 21 Calculated based on 2022 World Bank Open Data (World Bank. 2023. Urban population (% of total population) —Albania, Bosnia and Herzegovina, Montenegro, Kosovo, Serbia, and North Macedonia. Accessed January 2024. https://data.worldbank.org/indicator/SP.URB. TOTL.IN.ZS?locations=AL-BA-ME-XK-RS-MK.) Note: Excludes Kosovo as data are not available. 22 World Bank. 2019. Western Balkans and Croatia - Urbanization & Territorial Review. https://documents1.worldbank.org/curated/ en/306721565242541252/pdf/Overview.pdf. Note: Excludes Kosovo as data are not available. 48 11. Spotlight: Greening Cities INVIGORATING GROWTH the trend in recent years has reverted due to greatest decline of 2.1 percent. The average demographic decline. Capital cities in the city, as defined above—see Box 11.1, is small, region also appear to be underperforming: they with only 30,000 inhabitants, and population are growing more slowly than capital cities density is low, at around 942 inhabitants per in the EU and other parts of the region.23 In square kilometer. This is lower than other addition, they suffer from low productivity, countries in ECA or in most of the world.27 show only modest employment gains, and These characteristics do not lend themselves to have had relatively low or stagnant GDP agglomeration economies, and thus limit the growth since 2009.24 A changing climate is potential contribution that urban areas could exacerbating the existing pressures, with the make to overall productivity and national WB6 region exposed to more unpredictable economic growth. shocks, such as flash floods and wildfires, together with slow-onset stressors such as heat Figure 11.2. Annual urban population growth of the Western Balkan countries, and drought continuing to worsen. These 2000–2022 climate-triggered hazards pose a threat to cities’ Annual, percent economic potential and to their residents. 1.0 0.8 0.6 Small, sparse, and shrinking cities in the Western Balkans 0.4 0.2 Cities in the Western Balkans are often 0 small and sparsely populated, and they are -0.2 experiencing demographic decline, limiting -0.4 the potential of agglomeration economies. -0.6 2010 20 11 2012 2013 2014 2015 2016 20 17 2018 20 19 2000 20 01 2002 2003 2004 2005 2006 20 07 2008 2009 2020 20 21 22 Since the early 2000s, many Western Balkan 20 Source: World Bank staff calculations based on World Bank Urban cities, especially the smaller ones, have been Development Data. World Bank. 2023. Urban population growth (annual %) – Albania, Bosnia and Herzegovina, Montenegro, Kosovo, shrinking (though they are not necessarily in Serbia, North Macedonia. Accessed January 2024. https://data. worldbank.org/indicator/SP.URB.GROW?locations=AL-BA-ME-XK- economic decline), mainly because of changing RS-MK. Note: Excludes Kosovo as data are not available. demographics and outmigration.25 In the past two decades, the Western Balkan countries have shown a decreasing trend in annual population Cities: hotspots of climate change growth, with the annual percentage becoming negative since 2021 (Figure 11.2). In 2022, A changing climate has further increased the Western Balkan countries experienced an vulnerabilities, with WB6 cities exposed average annual urban population decline of to multiple natural hazards, such as urban 0.38 percent,26 with Serbia experiencing the floods, landslides, and extreme heat. Extreme 23 World Bank. 2019. Western Balkans and Croatia - Urbanization & Territorial Review. https://documents1.worldbank.org/curated/ en/306721565242541252/pdf/Overview.pdf. 24 Ibid. 25 Restrepo Cadavid, Paula, Grace Cineas, Luis E. Quintero, and Sofia Zhukova. 2017. Cities in Europe and Central Asia: A Shifting Story of Urban Growth and Decline. Washington, DC: World Bank. http://monstat.org/eng/pxweb.php. 26 Calculated based on World Bank Urban Development Data (World Bank. 2023. Urban population growth (annual %) – Albania, Bosnia and Herzegovina, Montenegro, Kosovo, Serbia, North Macedonia. Accessed January, 2024. https://data.worldbank.org/indicator/SP.URB. GROW?locations=AL-BA-ME-XK-RS-MK.) Note: Excludes Kosovo as data are not available. 27 World Bank. 2019. Western Balkans and Croatia - Urbanization & Territorial Review. https://documents1.worldbank.org/curated/ en/306721565242541252/pdf/Overview.pdf. 11. Spotlight: Greening Cities 49 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 heat in cities has worsened considerably—see prone to high landslide risks. Built-up surface the Western Balkans Regional Country Climate areas of 16.5 percent (about 6.3 percent of and Development Report (forthcoming) for the population) in urban centers currently details across each of the six countries. For face moderate to very high landslide risk.29 instance, Tirana, Shkodra, Vlora, Mostar, Meanwhile, the risk of urban floods, triggered Sarajevo, and Skopje are up to 4.5–7.5°C by intense rainfall, has been increasing in all hotter in summer compared with their rural WB6 countries in recent decades, leading to surroundings.28 In addition, many WB6 substantial damage and economic loss. cities, including Skopje (North Macedonia), Tetovo (North Macedonia), Sarajevo (BiH), Cities as potential agents for greener Belgrade (Serbia), and Pristina (Kosovo), also growth and development face increased PM2.5 concentrations and are Urban areas are not passive onlookers, among the most polluted in Europe in terms since they are not only large contributors of air quality, which has deteriorating effects to climate change, but also at the forefront on the environment and human health. of changes in policies and public sentiment. Moreover, urban expansion on steep slopes Globally, cities account for over 70 percent of has made larger cities in the Western Balkans total CO₂ emissions, mainly because of fossil Box 11.1. Defining cities and greenness  city is defined as a spatially contiguous, dense cluster of population grid cells in a global A 1 square kilometer population grid. Each cell has a population density of at least 1,500 people per square kilometer and the aggregate population of the set is at least 50,000. This definition was devised by the EC in collaboration with several other international organizations (Dijkstra et al. 2021) and is also officially endorsed by the United Nations Statistical Commission as a recommended method for making international comparisons of urban areas. This definition is used in place of official national definitions of cities in the WB6 countries to allow for standardized study and comparisons. Greenness measures a city’s environmental footprint, with greener cities having more positive or fewer detrimental effects on the environment. In this report, it is measured by greenhouse gas (GHG) emissions, specifically carbon dioxide (CO2) emissions, methane (CH4) emissions, air pollution (PM2.5), urban heat, and vegetation cover. Greenness is linked closely to climate change. For instance, particulate emissions are related to CO2 emissions, suggesting that measures to reduce local pollution may also help in climate change mitigation, and vice versa. Furthermore, enhancing urban vegetation not only cools cities, countering climate change and the urban heat island effect, but also captures atmospheric carbon. 28 World Bank. 2024 [Upcoming]. WB6 CCDR. 29 Based on overlapping European Landslide Susceptibility Map version 2 (ELSUS v2) with Global Human Settlement Layer (GHSL) dataset-GHS- SMOD R2023A and GHS-POP R2023A – GHS population grid (2020 and 2030). 50 11. Spotlight: Greening Cities INVIGORATING GROWTH fuels used in the transportation sector, and “Climate-Neutral and Smart Cities” by 2030 carbon-intensive materials and energy used in under the 2021 EU mission.35 the buildings sector.30 Within the WB6 region, Serbian cities were the leading contributors to Greening not only mitigates climate change, CO₂ emissions in 2018. More than 87 percent but is also good for growth, resilience, of CO₂ emissions came from the combustion and inclusion. Urban greening and climate of fossil fuels in Serbia, Montenegro, and actions yield significant benefits, according Bosnia and Herzegovina.31 Less compact cities to the “Triple-A” Dividend of Resilience36 emit even more GHG with their expanded framework from the WB6 Country Climate transportation system and greater energy and Development Report (CCDR), including needs. Indeed, cities can be vocal advocates of avoided losses, accelerated economic potential, climate action, often demonstrating new ways and amplified environmental and social co- to transition to a greener and more sustainable benefits. Climate actions in urban areas development path.32 These actions can promote sustainable economic development, include coordinated urban planning alongside especially in sectors such as transportation, investments in transportation infrastructure, energy, and waste management. Moreover, targeting both compactness and connectivity. investments in greening are also associated Investments in energy-efficient buildings (or with high developmental and environmental retrofits of existing structures) are expensive, but co-benefits, such as increased productivity, job their returns are high.33 Cities in the Western creation, improved aesthetics, and recreational Balkans are no stranger to climate action and values, and enhanced ecological values and they have already trialed many policies aimed biodiversity. Policy changes in managing waste at greening. Under the EU initiative “Green will be good for human health, air pollution, Agenda for the Western Balkans”,34 many and for methane emissions. For instance, the cities have pledged action to implement the Urban Renewal program in Albania has spent EU 40 percent GHG reduction target by 2030, more than €365 million and implemented and taken climate mitigation and adaptation 581 projects on urban requalification, facades, actions to be aligned with the European Green education, and green innovation, including Deal. Elbasan (Albania), Sarajevo (BiH) and transforming 29 main squares and seven Podgorica (Montenegro) are part of the 100 urban boulevards, and implementing 24 urban 30 Dasgupta, S., et al. 2022. Cutting global carbon emissions: Where do cities stand? https://blogs.worldbank.org/sustainablecities/cutting-global- carbon-emissions-where-do-cities-stand. 31 World Bank Blogs. Muldabayeva and Nikolic. 2023. Towards greener and more resilient cities in Serbia: How improved urban planning can help. https://blogs.worldbank.org/sustainablecities/towards-greener-and-more-resilient-cities-serbia-how-improved-urban-planning- can#:~:text=In%202018%2C%20the%20country’s%20cities,over%20the%20past%2010%20years. 32 Mukim, M., and M. Roberts (eds.). 2023. Thriving: Making Cities Green, Resilient, and Inclusive in a Changing Climate. © Washington, DC: World Bank. https://openknowledge.worldbank.org/entities/publication/7d290fa9-da18-53b6-a1a4-be6f7421d937. 33 Oikonomou, V., S. Ebrahimigharehbaghi and M. Peretto. 2023. Cost-benefit Analyses of Investments in the Energy Saving Measures of the Residential Sector in Central and Eastern Europe. Institute for European Energy and Climate Policy (IEECP). https://ieecp.org/wp-content/ uploads/2023/05/FOUR_SCENARIOS_VERSION_Greenpeace-_-IEECP.pdf. 34 European Commission. 2020. Guidelines for the Implementation of the Green Agenda for the Western Balkan. https://neighbourhood- enlargement.ec.europa.eu/system/files/2020-10/green_agenda_for_the_western_balkans_en.pdf. 35 European Commission. 2023. EU Mission: Climate-Neutral and Smart Cities. https://research-and-innovation.ec.europa.eu/funding/funding- opportunities/funding-programmes-and-open-calls/horizon-europe/eu-missions-horizon-europe/climate-neutral-and-smart-cities_en. 36 Developed in the WB6 CCDR. (World Bank. 2024 [upcoming]. Western Balkans 6 CCDR.) Original term is “Triple Dividend of Resilience”, modified in the WB6 CCDR to “Triple-A Dividend of Resilience” to hint at potential financial dividends from these economic and other co-benefits. Triple Dividend framework was developed and described in Tanner, T., et al. 2015. The Triple Dividend of Resilience: Realizing Development Goals through the Multiple Benefits of Disaster Risk Management, London and Washington, DC: Overseas Development Institute and World Bank. 11. Spotlight: Greening Cities 51 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 forestation programs.37 In cities such as particulate matter of 2.5 microns or less in Podgorica (Montenegro) and Skopje (North diameter (PM2.5) for a sample of 39 cities in the Macedonia), projects have been launched to region. It explores how these environmental enhance sustainable wastewater treatment outcomes correlate with fundamental urban and also safeguard people’s health and bring attributes, including size and development environmental benefits to the urban areas and level, offering insights into the “greenness” surrounding rivers and lakes.38 In Albania, of cities and their contributions to climate a €40 million investment in public building dynamics. This is followed by analyzing the retrofitting in urban areas for climate-resilience degree of extreme heat-related events in the and energy efficiency is expected to yield past few decades, focusing on the issue of rising massive returns, with energy savings alone intensity of urban heat islands in the region. accounting for €500 million.39 A. By and large, urban emissions in the Western Balkans are worse, relative to the region 11.2. How green are cities in the Western Balkans? Many cities in the region exceed safe Cities influence climate dynamics through PM2.5 levels and are among the most their carbon footprint, atmospheric polluted in Europe  (Figure 11.3). Skopje’s particulate matter concentrations, and (North Macedonia) annual mean PM2.5 biophysical attributes. Analyzing the extent of concentration levels are 4.5 times the World greenness of cities is crucial to understanding Health Organization’s (WHO) safe threshold, their role in exacerbating or mitigating climate Tetovo’s (North Macedonia) annual mean change, as urban areas are at the forefront of both PM2.5 concentration levels exceed it by over environmental challenges and opportunities for 8 times, and Sarajevo’s (BiH) levels are triple sustainability. The challenges faced by WB6 the recommended safe level, indicating a cities in terms of emissions and sustainability critical environmental health crisis.41 These are rather unique to the region. In recent years, cities, along with Belgrade (Serbia) and Pristina capitals in the WB6 have often been listed (Kosovo), are among the most polluted among Europe’s most polluted cities, and capitals in Europe. The main contributors are over 25 WB6 cities suffer from pollution that residential heating and cooking (using solid exceeds prescribed limit values.40 This section fuels), industrial activities, and transportation. focuses on analyzing key measures of the extent In winter months, residential heating bucks of greenness using data on carbon dioxide the trend. Figure 11.3a illustrates the average (CO2), methane emissions, and emissions of annual PM2.5 emissions across WB6 cities, 37 BIRN, Urban Renewal Database, 2020. http://rilindjaurbane.reporter.al/. 38 The Western Balkans Investment Framework (WBIF). 2023. Podgorica Wastewater Treatment Plant. Link; WBIF. 2023. Progress made on North Macedonia’s largest environmental project. https://www.wbif.eu/news-details/progress-made-north-macedonias-largest-environmental- project. 39 Novikova, A., Z. Szalay, M. Horváth et al. Assessment of energy-saving potential, associated costs and co-benefits of public buildings in Albania. Energy Efficiency 13, 1387–1407 (2020). https://doi.org/10.1007/s12053-020-09883-3. 40 Green Agenda for the Western Balkans. Regional Cooperation Council. 2021. https://balkangreenenergynews.com/wp-content/uploads/2021/10/ GAWB-ACTION-PLAN-Final-04.10.2021.pdf. 41 Regional Note on Air Quality Management in the Western Balkans: Bosnia and Herzegovina, Kosovo, and North Macedonia. World Bank. 2020. https://documents1.worldbank.org/curated/en/330811585586168639/pdf/Regional-Note-on-Air-Quality-Management-in-the-Western- Balkans-Bosnia-and-Herzegovina-Kosovo-and-North-Macedonia.pdf. 52 11. Spotlight: Greening Cities INVIGORATING GROWTH Figure 11.3. PM2.5 concentrations, in cities and by region a. Annual average PM2.5 concentration in cities b. Per capita PM2.5 emissions in WB6 and ECA regions Average PM2.5 emissions, 2015 (tonnes per year per capita) .0015 .0010 .0005 0 Europe and Central Asia Western Balkans (excl. Western Balkans) J Residential J Transport J Agriculture J Industry J Energy Source: Based on data for 39 Western Balkans cities (Panel a and b) and 1,307 ECA (excluding WB6) cities (Panel b) from the European Commission’s Global Human Settlement (GHS) Urban Centre Database R2019 (https://ghsl.jrc.ec.europa.eu/ghs_stat_ucdb2015mt_r2019a.php), which derives its PM2.5 emissions data from the EC’s Emissions Database for Global Atmospheric Research (EDGAR v5.0). highlighting a notably high concentration in Figure 11.4. Average fossil CO₂ emissions, by country the Sarajevo metropolitan area of Bosnia and 2015 (tonnes per year per capita) Herzegovina, followed closely by Skopje in .20 North Macedonia. Figure 11.3b shows that per capita PM2.5 emissions in the Western .15 Balkans are substantially greater than those in the rest of ECA. While industry and .10 transport contribute to PM2.5 emissions across ECA countries, the Western Balkans have a .05 noticeably larger footprint across all sectors, 0 especially in agriculture and energy. Podgorica ALB BiH KOS MNE MKD SRB (Montenegro) and Niš (Serbia) experience J Residential sector J Transport sector Source: Based on data for 39 Western Balkan cities from the the highest levels of residential combustion European Commission’s Global Human Settlement (GHS) Urban Centre Database R2019 (https://ghsl.jrc.ec.europa.eu/ghs_stat_ in the region, contributing to over 20 percent ucdb2015mt_r2019a.php), which derives its CO2 emissions data from the EC’s Emissions Database for Global Atmospheric Research of their total PM2.5 pollution, in contrast to (EDGAR v5.0). Notes: The bars show the unweighted average of long-cycle (fossil) cities in Bosnia and Herzegovina, where such CO2 emissions per capita (measured in tonnes per year per person) of cities. combustion constitutes around 10 percent of the overall PM2.5 pollution.42 only in the WB6 region but also in the wider Europe region.43 Both for the residential Given its greater reliance on renewable and transportation sectors, the average CO₂ energy for electricity supply, carbon dioxide emissions have been lower than the other five (CO2) emissions in Albanian cities are lower countries. At the opposite end of the spectrum, than the rest of the WB6 region. Albania Bosnia and Herzegovina stands out with has the lowest per-capita CO₂ emissions not the highest average production-based CO2 42 Status of air pollutants and GHG in the Western Balkans. European Commission JRC Science for Policy Report. 2020. https://publications.jrc. ec.europa.eu/repository/bitstream/JRC118679/air_qualityghg_western_balkans_online.pdf. 43 Multi-dimensional Review of the Western Balkans: From Analysis to Action. OECD. 2022. https://www.oecd-ilibrary.org/development/multi- dimensional-review-of-the-western-balkans_8824c5db-en. 11. Spotlight: Greening Cities 53 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 emissions from the residential sector, while (CH4) emissions. Increasing methane and emissions per capita from the transportation particulate matter emissions from waste sector are relatively consistent among WB6 decomposition and incomplete waste burning countries, with Serbia being the highest. The are large contributors to climate change residential sector is a significant source of and to air pollution. In Albania, the average emissions in each country, generally surpassing concentration of PM10 at Sharra solid waste the transportation sector (Figure 11.4). dump, located near the city of Tirana, is almost 10 times higher than the WHO standard.47 Emissions compound the effects of other Across WB6 countries, CH4 concentrations at hazards. Increasing CO₂ emissions are known dumpsites increased by 16.89 parts per billion to exacerbate urban heat islands, intensify air (ppb) in 2020, which is higher than the global pollution, and amplify climate-related risks annual rise of 15.23 ppb in 2020. Figure 11.5, in cities.44 Two climate change scenarios for panel (a), depicts the change in concentration the Western Balkans predict temperature of CH4 emissions in the region between 2019 increases of 0.8°C under the Representative and 2023. The densest clusters of increases Concentration Pathway 4.5 (RCP)45 scenario in CH4 emissions are in Serbia, Kosovo and by 2035, and a significant 1.0°C rise under the Bosnia and Herzegovina. In terms of per capita high-emission RCP8.5 scenario.46 CH4 emissions specifically for urban areas (Figure 11.5, panel b), Kosovo consistently has Unregulated and poorly managed landfills the highest numbers, followed by Serbia and have resulted in fires, aggravating methane Bosnia and Herzegovina. Figure 11.5. Change in methane emissions a. Methane growth rate (pbb/year), 2019–2023 b. Per-capita average methane emissions Per capita average methane emissions in urban areas, ppb 0.5 0.4 0.3 0.2 0.1 2019 2020 2021 2022 2023 ▬ ALB ▬ BiH ▬ KOS ▬ MKD ▬ MNE ▬ SRB Source: Methane emissions measured as Column-averaged dry air mixing ratio of methane, as parts-per-billion from Sentinel-5 Precursor Tropospheric Monitoring Instrument (TROPOMI). https://developers.google.com/earth-engine/datasets/catalog/COPERNICUS_S5P_OFFL_L3_ CH4#bands. Note: Urban areas defined using GHS-SMOD R2023A – GHS settlement layers, application of the Degree of Urbanisation methodology (stage I) to GHS-POP R2023A and GHS-BUILT-S R2023A, multitemporal (1975–2030). http://data.europa.eu/89h/a0df7a6f-49de-46ea-%209bde-563437a6e2ba. 44 To fulfill climate commitments in the Western Balkans there is a need for up-to-date GHG inventories and robust reporting mechanisms, currently only effectively maintained by Montenegro. 45 Representative Concentration Pathways (RCPs) model potential scenarios for carbon dioxide emissions or atmospheric concentration decreases throughout the century and represent GHGF trajectory forecasts adopted by the IPCC. 46 Study on Climate Change in the Western Balkans Region. EU Regional Cooperation Council. 2018. https://www.rcc.int/download/docs/2018- 05-Study-on-Climate-Change-in-WB-2a-lowres.pdf/06af8f7432484a6ce384ebcb8c05e8d7.pdf. 47 Besnik Baraj Merita Mansaku, Hotspot: Sharra Dumpsite in Tirana, Albania, Meksi EDEN Center. https://ipen.org/sites/default/files/documents/ alb1_sharra_dump_in_albania-en.pdf. 54 11. Spotlight: Greening Cities INVIGORATING GROWTH Figure 11.6. Relationship between city compactness and CO₂ emissions across cities, residential and transportation sectors a. Residential sector b. Transportation sector Log of fossil CO2 emissions, 2015 (tonnes/year) Log of fossil CO2 emissions, 2015 (tonnes/year) City compactness, 2015 City compactness, 2015 Source: World Bank analysis based on data for 2785 global cities from the European Commission’s Global Human Settlement (GHS) Urban Centre Database R2019. https://ghsl.jrc.ec.europa.eu/ghs_stat_ucdb2015mt_r2019a.php. which derives its data on PM2.5 emissions from the EC’s Emissions Database for Global Atmospheric Research (EDGAR v5.0). Note: The graphs shows the relationship between log CO2 emissions in 2015 and a measure of city compactness (the Polsby-Popper Ratio compactness index) controlling for the log of a city’s population, the log of its built-up area, a city’s climate (precipitation, temperature, biome) and elevation, and country fixed effects. More compact cities tend to have lower Figure 11.7. Determinants of air pollution (PM2.5) for cities in the region, residential production-based CO2 emissions from the and transportation sectors residential and transportation sectors. Figure Estimated effect on PM2.5 emissions 11.6 shows that, for cities in the region, more 2 compactness48 is associated with lower CO₂ 1 emissions. Effective urban planning, combined 0 with the effective regulation of land and real -1 estate markets, could limit urban sprawl. These policies, in turn, when coupled with -2 investments in public transportation, have -3 the potential to substantially reduce urban -4 Log, city Log, country Log, City emissions. population GDP per capita built-up area compactness J Residential J Transport Source: World Bank analysis based on data for 2785 global cities Compactness is also associated with lower from the European Commission’s Global Human Settlement (GHS) Urban Centre Database R2019, , which derives its data on PM2.5 PM2.5 emissions. Controlling for city specific emissions from the EC’s Emissions Database for Global Atmospheric Research (EDGAR v5.0). characteristics, such as city GDP per capita, Note: For each sector, the graph presents estimated coefficients, together with the associated 95 confidence intervals, from a and environmental and geographical factors, regression of a city’s log PM2.5 emissions on the log of its population density, the log of the city GDP per capita of the city, and a measure the relationship between compactness and of the city’s compactness (the Polsby-Popper Ratio compactness index) The regressions, which also include country fixed effects and estimated impact on PM2.5 emissions is also control for a city’s climate (precipitation, temperature, biome) and elevation, are based on cross-sectional data for 2015 with robust negative (Figure 11.7). In other words, for a standard errors. given level of development, more sprawling 48 City compactness refers to a development pattern characterized by a high density of buildings and infrastructure within a relatively small area. Here urban sprawl (inverse of city compactness) is defined as the percentage of undeveloped land/open space within a square kilometer around an average residential development (using 30mx30m cells) (Burchfield, M., Overman, H. G., Puga, D., & Turner, M. A. (2006). https://academic. oup.com/qje/article/121/2/587/1884022. 11. Spotlight: Greening Cities 55 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 cities are more polluted, given the longer B. Green cover across urban areas has average travel times usually compounded by improved over the past decade a lack of accessible public transit services. Overall green cover51 has improved in the Pristina (Kosovo) is the third most polluted Western Balkans, although some cities capital in Europe and grappling with urban experienced a decrease between 2015 and sprawl;49 private vehicles account for over half 2020. Studying the distinction between grey of its transportation modal share.50 urban areas and green spaces can serve as an indirect measure of greenness in cities.52 Figure Figure 11.8. Percentage of green cover in 11.8 shows the percentage of green cover within WB6 urban clusters cities53 (sorted by population) in the region. Belgrade Tirana Large cities in the region, such as Belgrade Skopje Sarajevo (Serbia), Skopje (North Macedonia), Sarajevo Novi Sad Pristina (BiH) and Pristina (Kosovo), witnessed an Niš Tetovo increase in green cover between 2015 and Durrës Podgorica 2020, whereas Tirana (Albania), Tetovo (North Kragujevac Banja Luka Prizren Macedonia) and Prizren (Kosovo), experienced Shkodër Drobeta-Turnu Severin a fall in overall green cover. Changes in green Subotica Elbasan cover could be linked to changes in land use, Zenica Tuzla but also by changes in CO₂ concentration. This Vlorë Čačak is because a changing climate is associated with Pec Zrenjanin an increase in stressors that undermine plant Bitola Mostar resilience, disrupting forests and ecosystems. Fier Slavonski Brod Korçë Prijedor Pogradec C. Cities are getting hotter—much Lushnjë hotter—lowering productivity and health Lezhë Gjirokastër outcomes Sarandë Kukës Peshkopi The frequency and intensity of extreme heat 0 10 20 30 40 50 60 events has increased rapidly since the 1990s. Percent of green cover Q 2015 Q 2020 The frequency of extreme heat events54 for WB6 Source: World Bank analysis based on data for 36 urban clusters cities increased from under three days a year in defined in GHS-POP R2023A – GHS population grid. European Commission, Joint Research Centre (JRC). Data on green cover the 1990s to over 40 days a year between 2011 obtained from Dynamic World 10m resolution land cover dataset. https://dynamicworld.app/. and 2020—a staggering 14-fold increase in just 49 One of the main contributors of sprawl in the Pristina is housing development, which comprises of over 25 percent of total urban land use (Pristina Urban Development Plan, 2013). 50 City of Pristina Green City Action Plan. European Bank for Reconstruction and Development. 2021. https://ebrdgreencities.com/assets/Uploads/ PDF/Pristina-GCAP_ENG_August-2021.pdf#:~:text=The%20private%20transport%20modal%20share%20in%20Pristina,transport%20 network%20very%20low.%20In%20addition%2C%20the. 51 Green cover is computed as the combination of tree and grass cover (measured from satellite imagery) and excludes cropland within an urban cluster. 52 Schut, A. G., T. E. Ivits, J. G. Conijin, B. ten Brink, and R. Fensholt. 2015. “Trends in Global Vegetation Activity and Climate Drivers Indicate a Decoupled Response to Climate Change.” PLoS ONE 10 (10): e0138013. https://journals.plos.org/plosone/article?id=10.1371/journal. pone.0138013. 53 Defined here as urban clusters which refers to a contiguous grid cells of 1 sq km with a population density of at least 300 per sq km and a total population of at least 5,000 (low-density threshold). 54 Extreme heat is defined as the average number of months a year a city’s temperature was extremely hot relative to its own historical experience. An extreme hot month is one in which a city’s temperature for that month is at least 2 standard deviations higher than the month’s city-specific historical norm, as calculated over the period January 1958–March 2012. Frequency is calculated as the number of nonconsecutive extreme hot months per year. Intensity is calculated as the average size of the anomaly variable during consecutive extreme hot months. 56 11. Spotlight: Greening Cities INVIGORATING GROWTH two decades (Figure 11.9, panel a). Even more region, as the number of heatwave days and the worrying, the intensity of extreme heat events frequency of long heatwaves rose in many EU also increased, albeit more gradually, over the capital cities between 1998 and 2015 compared same period (Figure 11.9, panel b). This trend with period between 1980 and 1997.55 has been observed throughout the broader EU Figure 11.9. Evolution of the frequency and intensity of extreme heat events for cities in Western Balkans, 1958–69 to 2011–20 a. Frequency b. Intensity Average number of months per year Average size of anomalies 1.5 2.6 1.32 1.0 2.4 2.35 2.32 2.29 0.63 2.24 0.5 2.2 2.18 0.17 0.15 0.09 2.05 0.01 0 2.0 1958–69 1970s 1980s 1990s 2000s 2011–20 1958–69 1970s 1980s 1990s 2000s 2011–20 Source: World Bank staff calculations based on Climatology Lab, TerraClimate. https://www.climatologylab.org/terraclimate.html; European Commission, Global Human Settlement (GHS) Urban Centre Database R2019. https://ghsl.jrc.ec.europa.eu/ghs_stat_ucdb2015mt_r2019a.php. Note: Panel a presents the average frequency and panel b the average intensity across the regional sample of urban centers that experienced an extreme hot month over the period January 1958–December 2020. Figure 11.10. Change in average heat wave magnitude index daily (1990–2040) a. Western Balkan region b. Major cities in the region Increase in average Heat Wave Magnitude Index daily, 1990–2040 Durrës Podgorica Shkoder Tirana Prizren Skopje Pristina Sarajevo Niš Banja Luka Čačak Tuzla Vlorë Kragujevac Zrenjanin Subotica Zenica Novi Sad Fier Belgrade 0 1 2 3 4 5 6 Source: Center for International Climate Research. ClimINVEST. https://www.arcgis.com/apps/MapSeries/index. html?appid=24aa80957be242a794114cd4c9054518. Note: Heat wave magnitude index daily (HWMId) is derived by combining the duration (in days) and the intensity (measured by daily maximum temperature) of extended extreme temperature events into one unified numerical index. Value for 1990 obtained as the average for historical model run from 1981–2000, and the projection for the year 2040 is the average of projections for 2031–2050. 55 Bednar-Friedl, B., et al. 2022. IPCC Sixth Assessment Report - Chapter 13 Europe. https://www.ipcc.ch/report/ar6/wg2/chapter/chapter-13/. 11. Spotlight: Greening Cities 57 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Box 11.2. Extreme heat will worsen existing inequalities Western Balkan cities experience ‘thermal inequalities’, with residents of the hottest neighborhoods exposed to more than 5°C higher temperatures than residents of the coolest neighborhoods. An innovative heat stress measurement campaign, conducted in August 2024, revealed striking differences in near-ground air temperatures experienced by residents of cities in Albania, and Bosnia and Herzegovina. Local community volunteers fitted temperature and humidity sensors to their vehicles and drove routes across their cities to collect thousands of temperature measurements, which were used to create area-wide heat maps. In Sarajevo, a temperature disparity of 7.4°C between the hottest and coolest neighborhoods was measured on the fieldwork day, while in Mostar the temperature disparity reached 8.2°C. Measurements in the Albanian cities of Tirana, Shkodra and Vlora showed temperature disparities in the 4–6°C range. Heat stress was shown to be systematically higher in neighborhoods with a high density of built-up surfaces, such as asphalt pavements, and a low incidence of grass, shrubs, and tree canopy. Broad physical interventions such as increasing shade cover and decreasing the use of heat-retaining materials such as concrete and asphalt are likely to mitigate the effects of urban heat. Integrating the results with social vulnerability information will help to identify the populations most in need of awareness- building and social safety net solutions. Community mapping participants recommended a range of actions to reduce the burden of heat stress on vulnerable communities, including increased shade, greenspace access, and support to residents who face health vulnerabilities or work in heat-exposed occupations. Figure 11.11. Average surface and air temperature patterns across urban to rural environments Temperature ▬ Surface temperature (day)  Air temperature (day) ▬ Surface temperature (night)  Air temperature (night) Source: United States Environmental Protection Agency. 58 11. Spotlight: Greening Cities INVIGORATING GROWTH More troublingly, the magnitude of management. And third, cities must take actions heatwaves is set to go up in the next few to reduce extreme urban heat and enhance decades. Between 1990 and 2040, Durrës preparedness for it. Green and blue measures, (Albania) will have the highest increase in the such as green roofs, urban parks and gardens, heat wave magnitude index among the sample ponds, and constructed wetlands, should be group of cities. This is followed by capital promoted given their low implementation cities in the region, namely Pristina, Podgorica, costs, and high environmental and social co- Sarajevo, Tirana, and Skopje (Figure 11.10). benefits, while hard and soft heat adaptation The number of heat waves is expected to account measures, such as shading and extreme heat for as much as 80 percent of summer months in early warning systems (HEWS) should also be a 4°C warmer world with the average summer implemented to reduce the effect of heatwaves temperature in the WB6 being projected to rise on human health. by up to 7.5°C compared with pre-industrial levels.56 These heat waves have implications for 1. Make cities more compact public health and socio-economic wellbeing— see Box 11.2, and have substantially negative Reducing urban sprawl will go a long way impacts on labor productivity in all sectors, toward making cities greener and will also especially the agriculture and construction contribute to growth. Cities that develop sectors. vertically are more prosperous, sustainable, and can accommodate more people with less land consumption.58 Denser cities depend 11.3. How to make cities greener? less on vehicular transportation and have more compact heating networks, which This report recommends action on three reduce GHG emissions and air pollution, main fronts to make cities in the Western and have other positive environmental effects. Balkans greener. First, it is crucial to reduce Compactness yields additional economic urban sprawl and make cities more compact. benefits. For example, it increases labor This can be done via urban regeneration and productivity and efficiencies in public service densification, mixed use of land57 in core areas, delivery, it leads to agglomeration effects of and the redevelopment of brownfields. Second, concentrating economic activity, and it is cities must bring down their emissions, not also associated with reduced costs, including only because this is good for the planet but also of infrastructure maintenance. Estimates of because this will have immediate improvement the average investment required for a package on socio-economic and environmental of good quality basic services in dense cities outcomes. The focus should be on key sectors (over 30,000 people per square kilometer) including transportation, buildings, and waste total around US$325 per capita, US$1,557 in 56 Turn down the heat: Confronting the new climate normal. The climate challenge for the Western Balkans. World Bank. 2019. https://documents1. worldbank.org/curated/en/494741468189532505/pdf/98220-WP-P148173-PUBLIC-Box393168B-pdf.pdf. 57 That combines multiple related uses, such as residential, commercial, cultural, institutional, or entertainment, into one space. See Raman, R., and U. K. Roy. 2019. Taxonomy of urban mixed land use planning. Land Use Policy. Volume 88, 2019, 104102. (https://doi.org/10.1016/j. landusepol.2019.104102.) Atlanta Regional Commission. 2011. Quality Growth Toolkit – Mixed Use Development. (https://web.archive.org/ web/20111128011547/http://www.atlantaregional.com/File Library/Local Gov Services/gs_cct_mixedusetool_1109.pdf.) 58 Mukim, Megha (ed.); Roberts, Mark (ed.). 2023. Thriving: Making Cities Green, Resilient, and Inclusive in a Changing Climate. © Washington, DC: World Bank. https://openknowledge.worldbank.org/entities/publication/7d290fa9-da18-53b6-a1a4-be6f7421d937. 11. Spotlight: Greening Cities 59 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 secondary urban centers, and US$2,837 in rural Greening and climate resilience should also areas (Foster and Briceño-Garmendia 2010). be mainstreamed into city strategies and Given the declining trend of urban populations planning. National strategic documents in in Western Balkan countries, it becomes the Western Balkans rarely consider urban even more crucial to enhance the density greening, nor are these actions mainstreamed of capital and people. Though often viewed in urban planning frameworks. Authorities, as a considerable regional challenge, urban both local and national, should consider population decline also presents an opportunity greening options, such as the implementation in promoting more compact urban designs, of rainwater harvesting, the creation of green as there is no pressing need to accommodate spaces such as urban parks, gardens and green growing populations in peripheral areas highly corridors, and the upgrading of wastewater exposed to climate shocks. Vertical expansion of management systems. In addition, nature-based urban facilities and public infrastructure should solutions, which have comparable functionality be promoted, while core urban areas should be to “gray” engineered solutions but often come targeted for high-density development of social with lower costs and are more environmentally infrastructure and mixed land use. Additional friendly, should also be promoted at the city actions could include the improvement of level.59 public transit capacity and the redevelopment of urban brownfields into urban green spaces, or 2. Cut emissions in sectors such as mixed-use land in line with community needs. transportation, buildings, and waste management These efforts could limit urban expansion (see Figure 11.12 for the city of Prishtina, Kosovo, Cutting GHG emissions is essential to as an example of compact city planning until the green urban transition, and the focus 2040), and contribute toward green and should be on sectors such as transportation, sustainable city development. buildings, and waste management. An integrated, smart transportation system would Figure 11.12. Contained urban expansion encourage urban residents to adopt more non- areas for Pristina until 2040 vehicular routines, also maximizing the use of public transportation. In addition, pedestrian and cycling networks should be expanded, with investment priorities given to locations around popular destinations, such as educational and health facilities, shopping centers, transportation hubs, and public green spaces. These actions should also be complemented by green transport policies that reduce GHG Source: World Bank, 2022. World Bank. 2022. Green, Low emissions from transportation sources, such as Carbon and Climate Resilient Pristina - Final Report. https:// documents1.worldbank.org/curated/en/099720106182224058/pdf/ the development of emission regulations or tax P1761860f76e7d0010b71706eb958154498.pdf. 59 Van Wesenbeeck, B., Mulder, J., Marchand, M., Reed, D., de Vries, M., de Vriend, H., Herman, P. Damming deltas. 2014. A practice of the past? Towards nature-based flood defenses. Estuar. Coast. Shelf Sci. 2014. 140, 1–6. https://www.sciencedirect.com/science/article/abs/pii/ S0272771413005556. 60 11. Spotlight: Greening Cities INVIGORATING GROWTH schemes for private cars to incentivize the use of solid waste, especially dumps and landfills, of alternative fuel vehicles. to reduce harmful methane emissions. Improvements in tools and technologies for Public and residential buildings should be data collection, and the upgrading of waste built (or retrofitted) to be energy efficient collection and treatment facilities would and resilient to climate risks, including be a good start. In addition, policies can be climate-triggered hazards. Clean domestic implemented to rehabilitate existing dump sites energy alternatives and energy efficiency to sanitary landfills and incentivize methane measures should be introduced to residential management best practices. Cities in the region buildings to replace domestic heating stoves are already taking action. For instance, in North that emit GHG and air pollutants through the Macedonia, a wastewater management project burning of coal and wood. This could reduce was launched in the capital city of Skopje in GHG emissions from domestic heating and 2022, which has helped Skopje transition to a provide a healthier, more sustainable, and green and climate-resilient city and assisted the lower carbon alternative for urban residents. country to align with EU environmental and In addition, building renovation programs that water laws and standards—it is worth noting aim to enhance climate and disaster resilience meeting performance targets related to solid should also be launched, with investment waste would also have an impact on future EU priorities given to public buildings such as accession.60 schools and medical centers. These could also serve as emergency shelters during a disaster 3. Tackle extreme heat in cities event. The investments should be supported with green building codes and regulations To mitigate the impact of extreme heat, that ensure energy and water efficiency of Western Balkan cities can adopt measures buildings, both for new construction and for to cool physical spaces where dangerous retrofitting existing buildings. To ensure its heat exposure occurs, including through full implementation, green codes should be greening, shade and urban design. Urban supported by construction monitoring and temperatures increase with the percentage of building inspections, as well as incentives for hard, impervious surfaces in cities, but decrease building owners, such as property tax discounts. with a higher percentage of tree canopy cover (Figure 11.13). Place-based cooling measures The urban waste management system needs include: greening at small scale (such as ‘pocket to be regulated and improved to reduce parks’) and large scale (such as urban forests emissions of methane and air pollutants. or ecological corridors); blue solutions such Poorly managed solid waste could generate as urban lakes, ponds, constructed wetlands, large amounts of methane, threatening the and fountains; and change in the design and health and safety of surrounding communities, construction of buildings. A review of 220 and contributing directly to climate change. local urban cooling measures around the world Hence, it is crucial to enhance management found that daily temperatures at project sites 60 WBIF. 2023. Progress made on North Macedonia’s largest environmental project. https://www.wbif.eu/news-details/progress-made-north- macedonias-largest-environmental-project. 11. Spotlight: Greening Cities 61 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Figure 11.13. Relationship between urban temperature and percentage of impervious surface (left) and tree canopy cover (right) a. Impervious Surface b. Tree Canopy Cover Temperature (°C) Temperature (°C) 32 32 30 30 28 28 26 26 24 24 0 20 40 60 80 100 0 20 40 60 80 100 Impervious Surface (percent) Canopy Cover (percent) Source: UHI intensity maps produced by VITO, conducting a simple scatter and regression versus the WorldCover tree canopy database. Note: Panels A represents temperature measurements (in °C) against the percentage of land cover that was impervious surface and Panel B represents the same with tree canopy cover. The relationship is measured between air temperature and ground cover characteristics with one dot representing a 100-meter grid cell. Measurement of near surface air temperature were recorded during vehicle traversed through a city. fell by 2°C in two-thirds of cases and more and response to health risks should also be than 2°C at the remaining sites.61 Water- promoted given their low implementation based interventions such as riverside walkways cost and high benefits from the heat-related yielded temperature decreases of more than 5°C mortality and morbidity averted. For instance, in some studies, while promoting significant extreme HEWS can be implemented by city co-benefits for physical and mental health, as authorities in partnership with national health well as the promotion of tourism and vibrant and meteorological agencies to provide residents commercial districts. with advance warning of heat waves, as well as medical information on actions that can protect In addition, city-wide adaptation measures their health in extreme conditions. Given should be implemented to reduce the health existing investments in weather forecasting impact of extreme heat on urban citizens, capabilities, the cost of introducing HEWSs is especially for those who are especially low, yet such measures can prevent deaths. In vulnerable such as children, the elderly, the Italian city of Florence, for example, a study ethnic minorities, and people with medical found the odds of mortality during a heatwave conditions. Hard heat adaptation measures, for frail elderly people decreased by 9 percent such as shading, air circulation systems, and after the introduction of a HEWS.48 drinking fountains, should be implemented in residential buildings and critical infrastructure, Information, incentives, and regulation can especially in key exposure settings such as equip cities for future heat waves. Extreme schools, health centers, and public transport heat is experienced in the physical spaces hubs. Meanwhile, soft measures that focus of a city: its streets, plazas, markets, homes, on enhancing public awareness, preparedness, workplaces, and transportation systems. 61 Santamouris, M., L. Ding, F. Fiorito, P. Oldfield, P. Osmond, R. Paolini, D. Prasad, and A. J. S. E. Synnefa. 2017. “Passive and Active Cooling for the Outdoor Built Environment: Analysis and Assessment of the Cooling Potential of Mitigation Technologies Using Performance Data from 220 Large Scale Projects.” Solar Energy 154: 14–33. https://www.sciencedirect.com/science/article/abs/pii/S0038092X16306004. 62 11. Spotlight: Greening Cities INVIGORATING GROWTH Table 11.1. Key categories of action to cool the physical spaces and prevent harmful heat exposure in cities Category Intervention type Example city Information and standard Public realm design manual promotes greening, wind-flow and Abu Dhabi setting shade Street tree planting: approved species list New York Direct public investment Development of a ‘green corridor’ ecological park Izmir Network of pocket parks favoring under-served areas Krakow Actions by city Residents provided with extreme heat early warnings and health Paris departments and budgets advice Transport agency plants wildflower verges on roadsides and London roundabouts Municipal park kept open longer during high heat alerts Ahmedabad School buildings retrofitted with green, shade and insulation Barcelona Incentive-based measures Cool roof rebates Athens Planning incentives for green space provision (Floor-Area Ratio Seattle bonus) City by-law (‘shade ordinance’) promotes shaded public spaces Sacramento Mandatory regulations Wind-flow requirements integrated in planning code Hong Kong Passive design regulations for cool building interiors Tokyo Congestion pricing regulating vehicle access to city centers Milan Source: World Bank staff elaboration. Considering the hotter climates that Western spaces; each measure promotes and incentivizes Balkans urban residents will experience by mid- the development of more livable city spaces and late-century, long-term and coordinated without requiring direct budgetary investment. efforts to make physical spaces cooler and prevent harmful heat exposure are important. Fortunately, cities in the region and globally 11.4. Leveraging existing are accumulating growing experience of actions opportunities that can mitigate heat stress, often at relatively Mayors can do far more to green cities in low cost. While direct public investment is the Western Balkans, especially if they required to create new green spaces such as combine forces with national and EU ecological corridors or pocket parks, cities stakeholders, and private capital markets. can also incentivize real estate developers and With limited financial and technical capacity individual citizens to plant trees and construct of national authorities and strained public buildings that stay cool (Table 11.1). Among debt after successive shocks, financing urban recent examples of heat resilience measures, greening relies heavily on local authorities, as Sacramento (United States) passed a by- well as private and international development law requiring shade awnings to be placed in partners. Already local authorities have parking lots, New York developed a list of tree implemented sustainable urban plans, invested species approved for planting in public spaces, in building retrofits, and developed urban and Abu Dhabi developed a design manual green spaces. They have an opportunity to do presenting recommended features for public far more, including by tapping external support 11. Spotlight: Greening Cities 63 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 from the EU and international programs. City Western Balkan cities in action authorities could work with the private sector to unlock green investment and financing Despite limited resources, and even opportunities, while the scope for crowding institutional constraints, cities in the in financing for green projects should not be region have already invested in promoting underestimated. green urban development. Several cities have developed strategic policies, some of which have also been implemented. These include investments in the modernization of Box 11.3. Green urban development in Serbia In 2019, Serbia developed its first Sustainable Urban Development Strategy, which was followed by an action plan in 2021. In addition, in the capital city of Belgrade, two climate change adaptation plans have been developed, namely the Climate Change Adaptation Action Plan and Vulnerability Assessment and the Sustainable Energy and Climate Action Plan. The measures under the plans include increasing water storage capacity, improving flood protection, promoting green infrastructure and renewable energy sources, improving public transportation, and retrofitting buildings for climate resilience and energy efficiency. The Green, Livable, Resilient Cities in Serbia Program, launched in 2021, also aims to strengthen national and municipal capacity, alongside promoting local economic development in lagging regions. Box 11.4. EBRD Green Cities Program in Bosnia and Herzegovina Cities in Bonsia and Herzegovina have been battling extreme heat and air pollution, while attempting to deal with issues such as inefficient usage of water resources and the lack of modern public transportation systems and waste management services. In this context, three cities—Banja Luka, Sarajevo, and Zenica—joined the EBRD Green Cities program to address their environmental and development challenges and enhance sustainable growth. Green City Action Plans have been developed for the three cities, while energy efficiency regulations and standards have been strengthened. In addition to policy reforms, green investments have also been implemented across the three cities, including improved drinking water quality, increased access to clean urban transport, and the installation of cleaner and more efficient heating measures for schools and hospitals. Such programs can have transformational impacts. It is estimated that green projects could reduce 376,000 tonnes of CO₂ emissions annually and save over 71,400 GJ of energy and almost 4 million m³ of water a year. Source: EBRD, 2023. 64 11. Spotlight: Greening Cities INVIGORATING GROWTH infrastructure, improvements to green building The leading role of the EU codes, and building local capabilities. Nature- based solutions, such as green roofs and urban The EU is a crucial stakeholder in this parks, are also popular, given the environmental context, with the ability to provide technical co-benefits and recreational values. Box 11.3 and financial support via several of its below showcases how urban greening has been initiatives. Under the EU initiative “Green promoted in Serbia. Agenda for the Western Balkans”,64 cities are encouraged to engage in green transformation There is also a suite of international contributing to the European Green Deal. programs that support urban greening in the According to the Action Plan for the Green Western Balkans. For instance, the United Agenda,65 sustainable urban mobility plans Nations Development Programme (UNDP), for major urban areas of the Western Balkans the European Bank for Reconstruction and will be developed and implemented by 2025, Development (EBRD), and the World Bank supported by smart cities digital platforms and have launched programs to assist sustainable dedicated applications. These plans combine urban development in the Western Balkans. different sustainable transport modes and EBRD’s Green Cities Program has been options, such as public transportation, car- implemented in several Western Balkan cities,62 sharing, car rental services, taxis, and public and aims to promote green and sustainable bike-sharing. growth of cities through the development of Green City Action Plans, sustainable Other EU initiatives, though not mandatory, infrastructure investments, and capacity- also promote greening and enhancing climate building (see Box 11.4 below for EBRD’s resilience of urban areas and, thus, should efforts in greening three cities in Bosnia and be encouraged among the Western Balkan Herzegovina). Companies can mainstream cities. For instance, as part of the Biodiversity climate-related activities into their business Strategy, the EC has called on European cities planning and invest in urban greening projects, to develop ambitious Urban Greening Plans, as well as investing in development and which include “measures to create biodiverse and deployment of new products or technologies in accessible urban forests, parks and gardens; urban the urban areas.63 farms; green roofs and walls; treelined streets; urban meadows; and urban hedges.”66 Local authorities in the Western Balkan cities could adopt the initiative and develop urban greening plans accordingly. In addition, under the EU 62 EBRD. 2024. EBRD Green Cities. https://www.ebrdgreencities.com/. 63 UNEP. 2016. Demystifying Adaptation Finance for the Private Sector. https://www.unepfi.org/themes/climate-change/demystifying-adaptation- finance-for-private-sector/. 64 European Commission. 2020. Guidelines for the Implementation of the Green Agenda for the Western Balkan. https://neighbourhood- enlargement.ec.europa.eu/system/files/2020-10/green_agenda_for_the_western_balkans_en.pdf. 65 Regional Cooperation Council. 2021. Action Plan for the Implementation of the Sofia Declaration on the Green Agenda for the Western Balkans 2021–2030. https://www.rcc.int/docs/596/action-plan-for-the-implementation-of-the-sofia-declaration-on-the-green-agenda-for-the-western- balkans-2021-2030. 66 European Commission. 2024. Urban Greening Platform. https://environment.ec.europa.eu/topics/urban-environment/urban-greening- platform_en. 11. Spotlight: Greening Cities 65 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.25  |  SPRING 2024 Covenant of Mayors for Climate and Energy,67 Serbia has issued its first sovereign green bond more than 9,000 cities and towns in Europe in 2021, and other green finance instruments, have committed to climate actions in line with such as microcredit and private equity, would the EU’s climate and energy policy framework. also be open to local authorities. Evidence Covenant signatories are required to develop a indicates that city-level greening actions are far Sustainable Energy and Climate Action Plan, more amenable to, and are being increasingly with the goal to reduce CO₂ emissions by at financed through, municipal (green) bonds, least 40 percent by 2030 and enhance climate tax increment financing, sale of development resilience. A few Western Balkan cities are rights, and other direct and indirect value already signatories to the Covenant, with scope capture strategies.70 In addition, policy actions for many more to sign up. Also, three Western can be taken to incentivize private capital Balkan cities, namely Elbasan (Albania), toward climate actions in the urban areas, such Sarajevo (BiH) and Podgorica (Montenegro), as investment in green urban infrastructure, have pledged to the EU mission “Climate- and innovations in green technology and clean Neutral and Smart Cities”,68 which aims to energy. It is estimated that green city investment deliver 100 climate-neutral and smart cities by needs in emerging markets until 2030 amount 2030. The commitment is to provide greener, to a total US$7.6 trillion.71 By making upfront cleaner, and healthier urban environments capital investments in urban greening through for the citizens, offer integrated, innovative green finance instruments, cities can improve solutions to urban living issues, and serve as their financial positions while running on lower experimentation and innovation hubs that help costs due to more effective urban planning and more European and Western Balkan cities to more efficient management of key sectors. With complete green transition by 2050. improved green finance instruments, standards and business sustainability, green finance could Crowding in innovative sources of be enhanced, which can effectively promote financing urban green transformation in the Western Greening is also an opportunity to bring Balkan countries. in more innovative sources of financing, both at the national and city levels. Western The stakes are high for cities in the Western Balkan countries are taking initial steps Balkans and potential investments in toward greening their financial sectors under greening could have high returns. The specter the assistance of European-owned banks and of climate change looms large, as evidenced by international institutions.69 Such actions can a notable increase in extreme heat events across also support urban greening. For instance, the region since the early 2000s, and the high 67 European Commission. 2024. Covenant of Mayors – Europe. https://eu-mayors.ec.europa.eu/en/home. 68 European Commission. 2023. EU Mission: Climate-Neutral and Smart Cities. https://research-and-innovation.ec.europa.eu/funding/funding- opportunities/funding-programmes-and-open-calls/horizon-europe/eu-missions-horizon-europe/climate-neutral-and-smart-cities_en. 69 World Bank. 2022. Western Balkans Regular Economic Report No.22 - Beyond the Crises. Washington, DC: World Bank Group. https:// openknowledge.worldbank.org/entities/publication/daee74fc-66e7-5e3f-84de-3cfdb30259e3. 70 Jones, R., Baker, T., Huet, K., Murphy, L. & Lewis, N. 2020. Treating ecological deficit with debt: the practical and political concerns with green bonds. Geoforum 114, 49–58. (https://www.sciencedirect.com/science/article/abs/pii/S0016718520301329?via%3Dihub); García-Lamarca, M., Anguelovski, I. & Venner, K. 2022. Challenging the financial capture of urban greening. Nat Commun 13, 7132. (https://www.nature.com/ articles/s41467-022-34942-x#citeas.) 71 Kapoor, P., and E. Robins. 2023. Three reasons why financial institutions should invest in green cities in emerging markets. World Bank Blogs. https://blogs.worldbank.org/sustainablecities/three-reasons-why-financial-institutions-should-invest-green-cities-emerging. 66 11. Spotlight: Greening Cities INVIGORATING GROWTH and growing levels of emissions and pollution, Balkan cities. The decisions made today, in the although with optimistic trends around green face of a changing climate and evolving urban cover. By making their cities more compact, landscapes, will shape not only the trajectory by reducing emissions, and by reducing of cities in the Western Balkans, but also the extreme urban heat, cities in the region have development of their national economies. Table an opportunity not just to mitigate the effects 11.2 below summarizes the actions required for of climate change but also to promote growth, greening the Western Balkan cities and public resilience, and inclusion, leading to a greener entities responsible for facilitating reforms and and more sustainable future for Western investments. Table 11.2. Policy actions for urban greening in the WB6 countries and main responsible institutions Actions Main Institutions Cross-cutting actions • Regional and supra-national institutions, including the European Commission (to be in the role of a core partner to national and sub- national governments) • National institutions such as the ministry of environment and the ministry of spatial planning (to establish relevant policies in national strategic documents) • Ministries of finance and/or national financial institutions (to facilitate the market for green finance) • Office of the Mayor and/or city council (to design, implement, and monitor relevant policies at city level) Action 1: Enhance city compactness • Ministries in charge of urban planning, public services, and strategic planning • Ministries in charge of transport and infrastructure Action 2: Cut emissions in key sectors • Ministries in charge of construction • Ministries in charge of water management • Ministries in charge of transport and/or infrastructure Action 3: Reduce urban heat and • Ministries in charge of urban planning, public services and strategic enhance preparedness planning • Ministries in charge of disaster and/or emergency management and response • National and/or municipal hydrometeorological service Source: World Bank staff elaboration. 11. Spotlight: Greening Cities 67 WESTERN BALKANS regular economic report No. 25 | Spring 2024 View this report online: www.worldbank.org/eca/wbrer