Western Balkan Transition Countries Face Their First Recession

February 19, 2009
By Dr Igor Matutinović
Life in an over-connected world

The world economic system has evolved to a state in which national economies are highly interconnected and interdependent. This means that what may at first sight appear to be a US economic problem could soon develop into a worldwide phenomenon, with its consequences sparing no one. The IMF recently cut its 2009 global economic growth projection to just 0.5%, a huge downward revision from its previous 2.2% forecast made in November. As recently as November 2008, the European Commission had predicted that the CEE countries would continue to grow in the next year, albeit at a slower pace. Current estimates now show that Hungary, Romania and Croatia should experience recession in 2009, while Serbia is likely to have zero growth.

Recent months have brought with them disturbing revelations of what is gradually becoming a truly global economic downturn. First, it became clear that the economic forecasts we have depended on are utterly unreliable: they change as the crisis unfolds, showing the inability of experts and their models to predict more than two months ahead. The world economy is too complex a system to yield itself to accurate predictions, especially in periods of turbulence, so policy makers had to shoot in the dark and were most likely to over- or undershoot their targets. Next, we discovered counterintuitive and unexpected causal links, such as the changes in the U.S. housing market and their influence on the contraction of the Croatian economy.

Who could have predicted that the subprime crisis, which exploded in mid-2007 in the U.S., would bring a recession to the Western Balkans in 2009? Especially since we knew that the financial sectors in the Balkan economies did not deal at all with toxic assets – those derivatives connected to subprime mortgages.

Countries that had not yet fully recovered from the transition crisis are now having their first encounter with the other side of that vaunted capitalist economic model, as they learn that the growth phase of the business cycle is invariably followed by a recession phase. They are also discovering that the causes and the timing of this recession, which they must dig their way out of, may be totally unrelated to what has been happening at the level of their national economies.

Signs of recession in the Western Balkans

The crisis in the region began with the meltdown of local stock markets in February 2008. By the end of the year, the indices had lost between 60 and 76% of their value. 

Croatia has now officially declared that it has entered a recession: the country reported a 0.5% decrease in GDP for the third quarter, and further losses are anticipated for the fourth quarter of 2008. The Zagreb Economic Institute forecasts a 1.4% decline of GDP for 2009, with recovery and growth of 2.3% likely in 2010. Early warning signs have been arriving from the export industry, which has been losing steam for the last two quarters. The impact on unemployment is still small, but it will probably increase over the next few months. At the moment, it is difficult to make accurate predictions of the size and duration of the first post-transition recession in Croatia, as it depends on several uncertain factors. First, it is contingent on how severe the recession in the EU will be.

The European Union is Croatia’s largest export market, as well as its major source of tourism. Second, Croatia has high external debt (estimated at €37.4 billion for 2008) that adds up to 89% of GDP, and €8.5 billion of that debt will come due in 2009. It will be difficult for Croatia to arrange debt refinancing in the current credit-crunch environment, and this will seriously undermine its financial ability to cope with recession and extend support to domestic industry. Nevertheless, its banking system remains uncontaminated by toxic assets, and the Croatian Central Bank (HNB) pursued a rather restrictive policy throughout 2008, which now leaves it with considerable space for increasing money supply and hence the credit potential of commercial banks. Foreign debt repayment and shrinking revenues from exports and possibly tourism will put pressure on the stability of the local currency, the kuna. Potential weakening of the kuna coupled with the likely rise in interest rates could present a perfect storm for highly indebted Croatian households, which may respond by defaulting and reducing their consumption even further.

Bosnia and Herzegovina present a similar picture. Their economy and households are highly indebted, and their export industry is highly dependent on West European markets. Besides the falling exports, there are signs of crisis in the real estate market, where prices are plunging (in the capital Sarajevo, for example, they have gone down by 20%), and in the rising interest rates and decreasing loan availability for industry and households. Industry in Bosnia and Herzegovina began shedding jobs in the fourth quarter of 2008 as a consequence of declining exports. On top of all of this is a chronically high unemployment rate, which stood at an impressive 40% as of November 2008.

To accompany its economic woes, BH has a precarious and fragile political situation that will be only exacerbated by a recession. Whether BH has officially entered a recession is still unknown, and may stay so for some time, because its statistics bureau monitors changes in GDP on only a yearly basis.

In Serbia, the export industry (mainly products for heavy industry) faced falling demand in world markets for the fourth quarter of 2008. The local currency of the dinar lost 12% against the euro in the last quarter of 2008, however, which may have helped the Serbian export sector a bit. On the other hand, the dinar’s volatility is undermining the country's already precarious economic stability. The amount of Serbian foreign debt (estimated at €21 billion for 2008, or 61% of GDP) means the country qualifies as only medium indebted, which may make it easier to access the foreign sources of liquidity necessary to support its export industry so that it can overcome the period of demand crisis.

Ability to counter recession

Just like the rest of the Europe, all three Balkan countries are attempting to counter their economic woes through anti-recession policies. They will receive financial support from the EBRD (European Bank for Reconstruction and Development) and EIB (European Investment Bank) to help them do so, via a program called the “Western Balkans Investment Framework”. Other likely sources for financial support to the region, and to the CEE countries in general, are the European Central Bank (ECB) and the IMF. The ECB recently received requests from nine major European banks, active in the region through their subsidiary networks, to provide additional funds that would help them maintain the liquidity of their CEE operations. In January 2009, the IMF granted a stand-by arrangement worth €402.5 million to Serbia so that the country could stabilise its financial sector and implement structural reforms aimed at increasing export competitiveness. The Serbian Central Bank slashed interest rates from 17.75% to 16.5%, and the government agreed on a €1 billion package aimed at helping its export industry. This makes Serbia so far the most active and responsive country in adopting policies aimed at preventing or mitigating recessionary effects. Croatia and BH are still expecting their governments to come through with anti-recession programmes. These programmes will most likely concentrate on fiscal and monetary policies that closely mirror those already applied in Western Europe and the CEE countries, but are expected to do so on a smaller scale that is compatible with these countries’ internal budgetary constraints and foreign currency reserves. The focus, however, will not be on recapitalising commercial banks or healing their balance sheets, but instead on helping the export industries in each respective country to bridge the crisis, and, more importantly, to maintain political stability and social peace.

The latter is very important in countries whose populations already suffered economic woes during the long transition period, when their economies contracted to an extent comparable to that of the Great Depression. Transition troubles, which incidentally were uniquely legitimised as a “necessary sacrifice”, wore out people’s capacity and willingness to endure yet another harsh period of unemployment, impoverishment, and economic insecurity. After all, wasn’t the promise of capitalism a sustained increase in the material standard of living? A severe and protracted world recession, one that might last until 2012 as forecast recently by Nobel laureate Paul Samuelson, could put social stability in the Western Balkans and the rest of Europe to a severe test. The only way through this challenge is to abandon the last remnants of neoliberal ideology and embrace the pragmatism that Keynes taught us long ago, which recognises the roles of both the state and the market in the functioning of modern economies. Post-transition countries should not be left to their own devices to learn that lesson.

Dr Igor Matutinović, born in Croatia, holds Ph.D. in ecological economics. Since 1999 managing director of the institute for market research GfK- Croatia, member of the GfK Group Nürenberg, Germany. Teaching market research at High Business School Zagreb. Member of a number of academic and professional associations, among other: Association for Evolutionary Economics (AFEE), International Society for Ecological Economics (ISEE), Croatian System Society (CROSS). Since 2003 member of the Program Comitee for sustainable development,HBS Zagreb Office.