28th August 2022 – Seven months have passed since the outbreak of the war in Ukraine. Economic outlook remains to be highly uncertain, accompanied by downside risks due to the rising inflation, the possibility for a shutdown of gas supplies from Russia, rising electricity prices, and tightened financing conditions. What each of the financial institutions dealing with forecasting, state under their reports, is that the economic forecasts are contingent on the evolution of the situation in Ukraine, i.e. the duration of the conflict and the sanctions imposed to and by Russia. Anyway, we should unquestionably hold back, as new potential COVID-19 waves or variant strains, are still a threat. Investors are divided – some believe that the crisis has been in full swing and the worst is behind us, while others consider that the current green marks in stock exchanges are oscillations before markets are in bear territory.
Since uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security (according to the famous American mathematician and university professor John Allen Paulos), I dedicate this column on recognizing the ongoing developments and the assumptions about the future, by which the readers will get a broader picture thereof, thus also helping them to draw useful conclusions about the available opportunities and strategies. Overview of the developments and the expectations about European economy, market trends, recommendations and measures taken by international financial institutions, as well as our activities, are briefly presented below. Systemic changes, which will make us more resilient to any new upcoming challenges are also indicated hereto.
Expectations about the European economy – potential contraction in the second half with a positive GDP forecast in 2022
Let us begin from Europe. I will hereby make an analogy, as per Metternich’s well-known saying – “when France sneezes, Europe catches a cold”. In fact, given that our economy is a small and extremely open one, which foreign trade accounts for 140% of GDP, and with around 80% of the exports being intended for the EU and 50% for Germany, it is quite logical that the developments in the EU and Germany affect us as well. They reflect, to a great extent, on the economic developments in our country.
Inflation in the EU continued to grow in July as well, mostly as a result of the increase in electricity prices. As per Eurostat data, it reached 9.8% in the EU, accounting for 8.9% in the Eurozone, thus being at all-time record high level. Estonia, Latvia and Lithuania recorded inflation rates of over 20%, while 16 out of 27 Member States, registered double-digit inflation. IMF July’s forecasts on economic growth in the Eurozone in 2022 and 2023 have been again revised downwards, also including larger European economies such as Germany, France and Italy. It is worth mentioning that GDP growth is expected in both 2022 and 2023, only significantly slowed down compared to the previous expectations. In fact, according to IMF’s Outlook in July, growth in the Eurozone is expected to account for 2.6% in 2022 and 1.2% in 2023, being by 0.2 p.p. and 1.1 p.p., respectively, lower compared to the April’s forecasts. Growth of the German economy is projected at 1.2% and 0.8% in 2022 and 2023 respectively being another downward revision by 0.9 p.p., i.e. 1.9 p.p. in relation to the IMF’s April forecasts.
Based on the Purchasing Managers Index, or an economic indicator about the trends in manufacturing and services sector, the business activity in the Eurozone contracted in August. While global price pressures have eased over the past few months as supply chain issues have been resolved, due to the threats stemming from the rising natural gas prices in Europe, as well as the reinforced domestic price pressures, the inflation will remain elevated.
As before, potential negative performance on quarterly basis was expected in the European economies throughout 2022. However, the developments have been further aggravated as evident from the European gas prices, surging by 50% since the end of July. Continuous rise in gas prices and the probability for them to remain high further on, indicates that the Eurozone economy will likely suffer deeper contraction than initially expected (although technically speaking it could be a matter of a recession, i.e. negative quarterly GDP growth, for two quarters in a raw – as explained above, the expectations about the annual growth are still positive). It is estimated that gas price will cause for the inflation in the Eurozone to be kept at around 10% in the upcoming months. Furthermore, high gas prices will provide for increasing the costs of companies, which will, in turn, reflect on their production and final costs, thus also affecting the core inflation. At the same time, the rise in the price of gas affected the fall of the euro against the dollar, thus increasing the import prices. In the meantime, domestic price pressures are also high. All this will affect the growth of core inflation in the Eurozone, which is expected to reach around 5% in the upcoming months, and to be afterwards kept at 4.5% in 2023.
Energy prices for European households and companies will be higher than the prior expectations. This will affect consumers’ confidence, which will be further undermined, with them being less willing to spend their savings, which will impact the consumption in the second half of the year. Energy price will also affect the investments. Higher costs and weaker prospects for final consumption will make the companies cut back on non-essential projects.
Tightening of ECB policy interest rate
Fiscal and monetary policy will be tightened. Although European governments are expected to provide support so as to cushion some of the effects from the higher energy prices for households and companies, it cannot be expected that they will offset all newly incurred costs. European Central Bank will certainly continue to tighten the monetary policy, which will slow down the growth. New increase in the policy interest rate by 0.50 percentage points is expected in September, whereby new tightening in October is also not excluded. Poor economy can put downward pressure on prices, however, it should be taken into account that both the supply and the demand are hit thereby.
According to the initial information on a national basis, as affected by the energy crisis, the German economy is not performing well, with its manufacturing and services activities at their weakest level since June 2020 as per PMI. It is expected for Germany and Italy to be most severely hit by the gas price surge. Industry will be most affected in Germany, while with respect to Italy, electricity generation would be most jeopardized given its gas dependence. French economy is less reliant on gas compared to most of the countries, which Government undertook measures aimed at supporting the households. Nevertheless, Spain is less reliant on Russian gas supplies compared to other European countries.
Genesis of the problem – the economic war via the energy products between Russia and the EU
Under the previous columns, I also wrote about threats from Russia-Ukraine war to the European economy. Europe relies on Russia for around 35% of its gas imports, while price of natural gas impacts the price of electricity. Price of electricity is included in the prices of domestic production, as well as the import prices of other products. As part of the sanctions against Russia, as well as Russia’s response thereto, Europe is, as planned, already reducing its dependence on Russian gas. Nevertheless, the provision of appropriate gas substitutes is a slow process. I will illustrate this with the fact that only the announcement by Russia’s Gazprom that it will suspend the gas supplies via the Nord Stream 1 for a few days after 31st August contributed to a sharp increase in the prices of gas and electricity on the European stock exchanges.
Price of gas reached approximately EUR 300 per megawatt-hour. Price of natural gas rose above $3,300 per 1,000 cubic meters. As an illustration, the price of this energy product has increased by a whopping 700% since mid-2021!
Price of electricity is also breaking records. At the end of August, 1-year forward electricity prices on exchanges in Germany and France hit intraday highs of 700 and 800 per MWh respectively. Nonetheless, France’s and Germany’s electricity exchanges dictate prices on the other stock exchanges in Europe, such as the Bulgarian, the Hungarian, the Slovenian… These price hikes also reflected on all regional stock exchanges, whereby the price rose to more than EUR 600 per MWh. Anyway, in 2021, the price above EUR 75-100 per MWh was considered expensive, whereas prices on the regional stock exchanges did not exceed EUR 50-75.
Energy experts expect that the developments will not change much by the end of this winter, except in case the war in Ukraine is brought to an end and Germany decides to import Russian gas via Nord Stream 1 and 2. Whereas, in case Germany, which predominantly affects the price of electricity on the European markets, further intends to stop using Russian gas, energy prices will remain high for several years.
What is peculiar, as written in the British Magazine “The Economist”, is that this is not only a conventional war between Russia and Ukraine, but rather a global hybrid warfare between the autocratic regimes from the East and the democratic systems in the West. This is a global geopolitical war with worldwide economic implications through energy resources, technologies, economic and financial sanctions on both sides, which can, in the medium term, have serious implications on the world order (this primarily implies to the relations of Russia and China with the EU and the USA), globalization, economic, financial and technological development.
The ongoing developments in the European states are already a huge economic shock on a global scale, with significant adverse consequences on our economy as well. It is a matter of a severe economic shock that is inevitable, which will affect us all, however, everyone has a duty to play their part in its cushioning by sharing the burden through savings, rationalization and reorganization. Government will surely continue to be active and assist in coping with this grave external economic shock.
Government’s measures aimed at cushioning the external shock
How will European difficulties affect our economy? – The methods are actually the same as before (I wrote about this when the war in Ukraine broke out), as follows: the inflationary trends (which will reflect on the domestic prices mostly due to the rising electricity price), the trade that will be impacted by the prudent consumption, all this being coupled by investment caution as well.
What can be done? Government is taking and will take measures, however, by keeping into account that much more developed economies than ours cannot fully cushion the shock, neither our country is expected to do so. Under its Economic Outlook in July, IMF staff urged once again that systemic and targeted measures should be put in place.
It is recommended to allow the effectuation of the market forces of supply and demand, with support being provided to the most vulnerable categories. Price signals are crucial for both adequate demand response and beginning of the stabilization.
Demand for energy is flexible, i.e. price increase leads to lower demand, whereby in time, such lower demand will result in price stabilization.
Measures aimed at cushioning the rising electricity prices have been undertaken for a year already, via the ESM (Macedonian Power Plants) subsidies and the reduced VAT on electricity from 18% to 5% (meaning around EUR 50 million less VAT revenues annually under the State Budget). However, we must all be aware of the magnitude of this external blow. In fact, price of electricity on the regulated market in our country is by 5 times lower than the market price of electricity – this is the support provided to households and certain companies on the regulated electricity market. Difference among the cost price and the selling price of electricity provided to households by the state-owned company ESM on the regulated market, as well as the losses of the transmission and distribution network (thus contributing to a lower price of electricity for companies on the liberalized electricity market), exceeds EUR 200 million per year. However, prices on the stock exchanges continue to increase, thus also leading to higher Budget costs. Therefore, other measures should be undertaken in addition to the subsidies and the foregone revenues. Measures for saving electricity should be immediately undertaken by all public sector institutions and private sector entities, as well as in each household. Simply put, each and every citizen should personally contribute thereto – as per the maxim “MAKE SAVINGS AND CARRY ON!” by following the example of Great Britain, which before the bombings during the Second World War, published posters with the slogan “Keep Calm and Carry On!”.
In the medium term, we should be committed to energy efficiency, as well as new sustainable sources further on. If we all fail to become more responsible, nothing could be achieved. We just manage to transfer the expenses from one pocket to another, since we all pay the respective taxes.
With respect to the other measures, under the Budget, funds amounting to EUR 76 million have been allocated for new anti-crisis measures. Additional budget funds have been provided, around EUR 100 million more for guaranteed minimum income, as well as for agricultural subsidies. Wages were increased in health, police and judiciary sectors, accompanied by the minimum wage increase, as well as higher wages in the private sector via the subsidies provided thereto. In addition to the budget funds, EUR 200 million was provided by the European Bank for Reconstruction and Development, intended for ESM and EUR 100 million via the European Investment Bank, as support to the business sector. There are also ongoing negotiations with the European Commission and the EIB within the Economic Development Program, pertaining to funds, by which EUR 250 million will be provided for the Guarantee Scheme. Most recent measure adopted last week as support to the liquidity of companies is the gradual reduction of the legally set deadline for settling the liabilities of the public sector towards the private sector.
Government is undertaking activities for the new set of anti-crisis measures, whereby the Prime Minister and the Government’s economic team are in close coordination with the business community and all social actors so as to find the most appropriate solutions to support the citizens and the business sector, in particular the most vulnerable categories via targeted measures.
Long-term solution
All these measures will partially cushion any external shocks. In this respect, I am for always being real rather than embellishing the truth. Rough winter lies ahead of both our country and Europe. Government measures will only manage to cushion rather than entirely halt such blow – neither will the rich economies be able to do so. What we all need to do is to take the general awareness as a starting point and discuss which are the best options for us as a whole, rather than choose those only for our own sake. It is very clear that everyone is trying to solve his/her personal issues and that they seem as the most serious ones when compared to others, however, most optimal results and minimal consequences can be attained only if we all think as a single collective unit.
Thus, I get to the last point, that being the systemic changes as the long-term solution. In order for the absorptive capability of the economy, in times of crisis, to be significantly stronger in future – as well as for the purpose of rendering better-quality public services, changes must be made on the revenue side (and undoubtedly greater control on the expenditure side, which is be attained through the systemic organic Budget Law). To the end of providing sustainable public finance, it is necessary to revise and streamline the budget expenditures through systemic and sustainable solutions. This implies structural reforms carried out by the relevant ministries and institutions, all to the end of optimizing and increasing the efficiency of the state administration, providing better-quality health and education, revising the agricultural subsidies based on the harvest and providing strategic products, social insurance, as well as improving the performance of public enterprises. We will also continue to further reduce all non-priority expenses, such as travel expenses, per diems, costs related electricity and other energy products, furniture, vehicles and similar. Therefore, now is the right time to talk about the optimal concept of taxation, also including measures aimed at eradicating the informal economy, which will provide for sufficient revenues as a buffer in case of any similar disturbances in future. The debate is open, taking place continuously with all stakeholders, with whom we will, altogether, reach the most optimal solution. Such measures require funds and sources must be available therefor such as improved collection or a loan. If the tax system was more efficiently and fairly set up with a greater tax scope (I am hereby referring to the informal economy as well), the absorptive capability of the economy would have been now larger and the need for borrowing lower.
And finally – I will mention again the energy efficiency with green and sustainable economy in place. In future, prosperous economies will be those, which a high level of sustainability. The ongoing crisis and the previous one have shown us that a higher degree of adaptability of economies is required. Those able to quickly respond to the challenges are the ones to succeed. Investments in sustainable energy sources are only one segment thereof. Sustainable agriculture is another fragment. Sustainability will be the key word in future. Thus, innovations and entrepreneurship will produce the greatest value added thereto and it is worth thinking thereabout.
“We do not inherit the earth from our ancestors, we borrow it from our children”. (Proverb)
Fatmir Besimi, Minister of Finance
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