The (economic) ties that bind: The western Balkans and the EU

The European Commission’s February 2018 communication on ‘A credible enlargement perspective for and enhanced EU engagement with the Western Balkans’[1] calls for a redoubling of efforts from countries in the region to ‘…address vital reforms and complete their political, economic and social transformation, bringing all stakeholders on board from across the political spectrum and from civil society’.

The communication also sets an indicative deadline (2025) for admission to the EU of the two most advanced candidates – Serbia and Montenegro. This new political impulse could incentivise all western Balkan countries to remove domestic political obstacles to EU accession, solve conflicts with neighbours, speed up reforms and accelerate economic growth.

For its own part, the EU and its Member States must not overlook the strategic importance of the western Balkan region. Geographically, Western Balkan countries form a land bridge and the shortest transit route between the south-east flank of the EU and its central European core. The importance of this transit route was demonstrated during the 2015-16 refugee crisis.

Close economic partnership

In this blog post, we review the economic linkages between the western Balkans and the EU. It is worth noting that western Balkan economies are already closely integrated with the EU; the EU is their largest trade partner, their largest source of incoming foreign investment and other financial flows, and the main destination for outward migration. Monetary and financial systems in the region are strongly dependent on the euro.

These close economic relations have been boosted by, among others, the Stabilisation and Association Agreements between the EU and individual western Balkan countries, which also include provisions for a Deep and Comprehensive Free Trade Area. Implementation of these provisions means elimination of tariffs and non-tariff barriers, liberalisation of trade in services and investment regimes, and far-reaching harmonisation of various trade and investment-related regulations and institutions – especially in the areas of competition policy, state aid and public procurement.

The agreement with Macedonia entered into force in 2004, with Albania in 2009, with Montenegro in 2010, with Serbia in 2013, with Bosnia and Herzegovina in 2015 and with Kosovo in 2016. In addition, the EU has promoted a network of horizontal free trade agreements between candidate countries using the umbrella of the Central European Free Trade Agreement, which currently involves all six western Balkan countries and Moldova.

Monetary regimes

In the second half of the 1990s and the early 2000s, currency pegs to the German mark and then to the euro helped Croatia (already an EU member), Macedonia, Bosnia and Herzegovina, and also Montenegro and Kosovo to disinflate quickly, given their legacies of high inflation/hyperinflation in the early 1990s.

Since then, Kosovo and Montenegro have taken up the euro as their currency, Bosnia and Herzegovina has a euro-denominated currency board, and Macedonia pegs to the euro (in a relatively narrow horizontal band). Exchange-rate regimes in Albania and Serbia can be characterised as managed floats, and both countries have declared inflation-targeting frameworks.

Apart from official euro-isation, all western Balkan countries – regardless of their declared and actual monetary regimes – experience far-reaching, spontaneous euro-isation of their financial systems (Table 1; note this data does not include euro or dollar cash holdings). Spontaneous euro-isation is not a problem in Kosovo and Montenegro, where the euro has been adopted as the official national currency, but it is a serious vulnerability in other countries.

Furthermore, despite successful disinflation and repeated recommendations from the IMF, there has been no visible progress in reducing euro-isation (Table 1) in favour of assets and liabilities in national currencies. From that perspective a hard peg (unilateral euro-isation or a credible currency board) can be seen as the factor that increases financial stability (thanks to the elimination of currency depreciation risk) and recognises the high exposure of the region to euro-denominated transactions in trade, tourist services and remittance flows, among others.

Trade

Figures 1 and 2 show that the EU and western Balkan neighbours are the dominant trade partners of each western Balkan country, accounting together for at least 70% of their total trade. For western Balkan countries’ exports, this dominance is even stronger. Evidently, then, the region is already closely integrated with the EU in terms of trade links, even if the EU’s share has declined slightly compared to 2006.

Among other partners, Russia has played some role in supplying the region, especially Serbia, Macedonia and Bosnia and Herzegovina, with energy resources (oil and gas) – but Russia’s role has gradually diminished over time (despite Russia’s interest in the western Balkan energy sector and the Druzhba and Adriatic pipelines). Russia is also one of the destinations for Serbian exports, but not exceeding a small percentage of the total.

The shares of China and Turkey are also limited and concentrated on the import side. However, the growth in imports from both countries is very high, so their shares might increase in future.

Outward migration and labour remittances

Not surprisingly, a large proportion of the western Balkan population has emigrated to more developed countries (in particular to western and northern Europe), as a result of the violent conflicts of the 1990s, lower income per capita and chronic high unemployment, especially of young people (see Dabrowski and Myachenkova, 2018). Mass emigration started in the 1960s from the former Yugoslavia and in the early 1990s from Albania.

In 2015, according to the UN data, Bosnia and Herzegovina and Albania had the largest shares of their nationals living permanently abroad – 46.7% and 38.4% respectively. Other countries accounted for smaller but still substantial shares of outgoing migrants. In Macedonia it was 24.8% of the population, in Montenegro 22.0% and in Serbia 10.9% (data for Kosovo is missing).

As a result, personal remittances (originating largely in the EU) play an important economic and social role in all western Balkan countries except Macedonia (Table 2). They help to finance large trade deficits and diminish current account deficits.

In Kosovo and Bosnia and Herzegovina, these remittances as a share of GDP exceed 10%; in Albania, Montenegro and Serbia they amount to slightly less than 10%. Since 2000, their relative importance has gradually decreased in Bosnia and Herzegovina, Kosovo, Albania and Macedonia, while it has increased in Montenegro and remained broadly stable in Serbia.

Foreign direct investment

Most foreign direct investment (FDI) in western Balkan countries, except Kosovo, originates from the EU (Figure 3). Progress in EU accession might bring even more European FDI (Stehrer and Holzner, 2018).

Other major sources of FDI in the western Balkans include Switzerland (entire region), Canada (Albania), Serbia (Bosnia and Herzegovina, Montenegro), Russia (Montenegro, Bosnia and Herzegovina, Serbia), Turkey (Albania, Kosovo, Macedonia) and Norway (Serbia) (Hunya and Schwarzhappel, 2016).

Despite the lost decade of the 1990s, FDI inflows into western Balkan countries accelerated in the 2000s and 2010s, including the period following the 2008-09 global financial crisis (Table 3). As a result, the cumulative stock of inward FDI relative to GDP exceeds the average in transition economies (Figure 4). Montenegro is the absolute leader, with the stock of FDI in 2016 equal to 113.0% of GDP.

FDI has mainly been directed at the financial sector, telecommunications, the energy sector, wholesale and retail, construction, real estate and manufacturing (Estrin and Uvalic, 2016; Hunya and Schwarzhappel, 2016).

Banking sector at the forefront of integration with the EU

The region’s banking sector is owned largely by foreign investors, predominantly from the EU. Many banks in western Balkan countries are part of pan-European banking groups. This concerns, for example, Raiffeisen Bank (Austria), which has its daughter banks in Albania, Bosnia and Herzegovina, Kosovo and Serbia; Intesa Sanpaolo (Italy), with subsidiaries in Albania, Bosnia and Herzegovina and Serbia; National Bank of Greece, owning subsidiaries in Albania and Macedonia; UniCredit (Italy), in Bosnia and Herzegovina and Serbia; Societe Generale (France), in Albania, Macedonia and Serbia; Nova Ljubljanska Banka (Slovenia), in all western Balkan countries except for Albania; and Pireaus Bank (Greece), in Albania and Serbia.

Progress in EU accession

Progress in EU accession can further strengthen economic ties between six western Balkan countries and the EU, with benefits for both sides.

Montenegro is the most advanced in this process. It started membership negotiations in 2012 and, by December 2017, it had managed to open 30 out of 35 negotiation chapters of the acquis communautaire (the body of EU law). The non-started chapters are competition policy, economic and monetary policy, environment and climate change, institutions and ‘other issues’. Three chapters (science and research, education and culture, and external relations) have been already provisionally closed.

Serbia is less advanced. It started membership negotiation in January 2014. By December 2017, it had managed to open negotiation on only 12 chapters (public procurement, company law, intellectual property law, enterprise and industrial policy, judiciary and fundamental rights, justice, freedom and security, science and research, education and culture, customs union, external relations, financial control, and ‘other issues’) and had provisionally closed only two chapters – on science and research, and education and culture.

Macedonia and Albania wait to start membership negotiations, while Bosnia and Herzegovina and Kosovo – have yet to obtain EU candidate status.

[1] https://ec.europa.eu/commission/sites/beta-political/files/communication-credible-enlargement-perspective-western-balkans_en.pdf

References

Dabrowski, M. and Y. Myachenkova (2018) ‘The Western Balkans on the road to the European Union’, Bruegel Policy Contribution, No. 04/2018, 22 February, available at https://bruegel.org/wp-content/uploads/2018/02/PC-04_2018.pdf

Estrin, S. and M. Uvalic (2016) ‘Foreign direct investment in the Western Balkans: what role has it played during transition?’ Comparative Economic Studies 58(3): 455-483

Hunya, G. and M. Schwarzhappel (2016) FDI in Central, East and Southeast Europe: Slump despite Global Upturn, FDI Report 2016, The Vienna Institute for International Economic Studies, available at https://wiiw.ac.at/slump-despite-global-upturn-dlp-3899.pdf

Stehrer, R. and M. Holzner (2018) ‘Western Balkan countries knocking on EU’s door’, News & Opinions, The Vienna Institute for International Economic Studies, 5 February, available at https://wiiw.ac.at/n-282.html