29th April 2023, Skopje – This month, I, together with the Governor of the National Bank, took part at WB/IMF Spring Meetings. It is a matter of one of the most significant annual economic and financial events, wherein policy makers from the whole world, international financial institutions, investors and NGOs discuss, debate, both multilaterally and bilaterally, the challenges, the projects and the present and future trajectory of the economy. Building resilient economies, generating growth, effective management in times of crises, human capital investments, acceleration of the green transition and the digitalization were among the numerous topics of discussions at this year’s Annual Spring Meetings. However, managing and assessing the effects from the overlapping crises in a very short period of time, affecting the global economy, as well as the still present risks that might disrupt the path to economic recovery, remained to be the center of attention. We overcome the pandemic with plenty of lessons learned, however, new challenges are ahead of the whole world.
Global Slowdown of the Economic Growth and Inflation Inertia
This is actually reflected in the latest forecasts on the global economy and the region by the international financial institutions. Under the IMF World Economic Outlook April, being titled Rocky Recovery, it was concluded that the process of recovery from the several overlapping crises was never going to be an “easy ride”. World Bank is even more illustrative in its assessments as evident even from title of its latest Europe and Central Asia Economic Update “Weak Growth, High Inflation and a Cost-of-Living Crisis”. All assessments demonstrate that although the global economy is allegedly recovering, the threats are still present, also including those from the new turmoil in the financial sector.
As per the latest IMF Spring forecasts, global economic growth will fall to 2.8% in 2023 compared to the last year’s 3.4% growth. In 2024, global economic growth is forecast to moderately grow to 3%, being actually the lowest medium-term global growth projection since 1990, as underlined by IMF Managing Director, Kristalina Georgieva, immediately prior to the Spring Meetings. Advanced economies, in particular, the Eurozone and the United Kingdom are expected to see an especially pronounced growth slowdown. Inflation is easing, although with slower pace than the initial expectations, thus it is forecast to decline from 8.7% in 2022 to 7% in 2023, to be followed by its 4.9% projection in 2024. However, the recent developments with the banks in the US and Europe brought to mind the great delicacy of the ongoing circumstances. In addition, inflation has remained stubbornly high despite the expectations. In a plausible IFM alternative scenario with further financial sector stress, global growth declines to about 2.5 percent in 2023, being the weakest growth since the global downturn of 2001, barring the initial COVID-19 crisis in 2020 and the global financial crisis in 2009. Strongly tightened financial conditions is a potential risk for both credits and public finances, in particular in the developing countries. Moreover, tightened financial conditions will provide for contracting the global economic activity, due to the undermined confidence, the lower consumption, as well as less investments, coupled by the existing risks from the ongoing war in Ukraine and the rising geoeconomic fragmentation.
WB April forecasts are similar, also expecting slowdown of the economic activity in 2023, as a result of the tightened financial conditions and the recent developments in the banking sector in the USA, causing additional risks, affecting the Eurozone as well. Potential spillovers and greater precaution pose a threat for the markets and the developing economies, being also a risk in terms of further slowdown of the economic activity. Service activity appears to have stabilized, as evidenced from the Purchasing Managers’ Index (PMI), getting back in the positive zone in February 2023 after six months, mostly as a result of the intensified activity in the service sector. However, PMI demonstrates that the activity in the production sector lags behind the services sector. China’s economic reopening is poised to boost global growth, however the effect on global trade will be more modest.
Economic Slowdown in the Region
World Bank forecasts for the growth in Europe and Central Asia region, excluding Russia and Ukraine, as well as Turkey where a divesting earthquake occurred, to fall to 1.8%. Growth slowdown prospects reflect dampened private consumption and investments, amid additional tightening of global financial conditions, weaker external demand and persistent inflation. Sustained weakness in external demand is projected to hamper exports, as activity in the euro area continues to soften and spillovers from the reopening of China’s economy remain modest. Expectations about scaling up private and foreign direct investments in the developing countries are not too optimistic. On the other hand, public investments will be subdued due to the need for fiscal consolidation. Fiscal consolidation will be a priority to restore fiscal space in most of the region, upon the substantial fiscal support provided by the Governments, all to the end of overcoming the energy and price crisis. So far, consumption has been one of the drivers of growth in the region, however, as inflation remains high and given the need for fiscal consolidation, it is unlikely to remain as strong a driver in the near term.
Western Balkans are projected to experience a slowdown of the economic activity due to the spillover effects from Russia’s invasion of Ukraine, lower private consumption, tighter global financial conditions, and a decline in demand from the EU Member States. World Bank projects for growth to weaken to 2.5% in 2023 from 3% in 2022. Growth is projected to pick up moderately to 3.4% during 2024-25. However, downside risks dominate the outlook, mostly associated with sustained inflation eroding disposable incomes and consumer confidence, as well as slowdown in the euro area, the Western Balkans’ main trading partner. Further tightening of global financial conditions could hamper access to external market financing. Weaker growth in the euro area will also decrease remittances from abroad, subsequently causing a decrease in private consumption in remittance-reliant economies. Returns to pre-pandemic tourist levels in the economies most reliant on tourism, provided for boosting the services sector in the Western Balkans as well.
Expectations about the Domestic Economy
When it is a matter of our country, upon the swift and successful recovery from the pandemic, the energy crisis and the war in Ukraine led to slowdown of the economic growth. Governments’ efficient and prompt response via the subsidized electricity price for the households and some of the small and medium-sized enterprises, as well as the minimum wage growth, provided for cushioning few of these global adverse effects. WB and IMF Reports welcome the adequate response to the inflation by carrying out fiscal consolidation and tightening the monetary policy, all to the end of anchoring inflation expectations. Adequate policies were also basis for improving the credit rating of our country, i.e. its outlook (from negative to stable), for the first time in the last four years. (Fitch Credit Agency revised our country’s rating to BB + stable outlook).
As a result of the global factors, related to inflation and combatting inflation, the World Bank, as same as our Government, projects somewhat slowdown of the growth in 2023 compared to 2022 (2.4% growth). Growth will be further in the country, as well as the inflow of foreign direct investments, whereby reduced inflation is expected during both this and next year. However, any further developments in our small and open economy will remain to be closely connected with our major trading partner – the European Union. World Bank staff realized that EU integration will be headwinds in implementing the structural reforms, as well as boosting the economic growth. Tax reforms are also mentioned in the light thereof, being geared towards expanding the tax base, increasing the energy sustainability, carrying out activities aimed at additional streamlining of the doing business regulations, boosting the competitiveness, increasing the inclusion on the labour market, strengthening the independence of public institutions and green transition.
Growth Acceleration Plan is also focused on intensifying the economic growth in our country, with the multiplying effect being used for mobilization of the private capital, in addition to the public investments. It is expected for the new instruments and sources of financing to provide for scaled up public and private investments, from year to year, thus creating value added in the economy, and boosting the economic growth, by reaching the desired rates of around 5%.
Poor and Low-Income Households – Most Affected by the Crisis Due to the Higher Costs of Living
Upon reviewing the ongoing global and national developments, I would like to get back to the genesis of the problem – the inflation, overlapping with the energy crisis, as well as the still visible effects from the pandemic. Upon a long period of low inflation, uneven post-pandemic recovery of the market supply and the market demand, as well as Russia’s invasion of Ukraine resulted in high price surge. In September 2022, average annual inflation in Europe and Central Asia Region reached record high level compared with the past 23 years, while households confronted severe crisis related to the costs of living and the adverse impact on the real income. Significantly higher costs for food, energy products, housing and services caused a reduction in the living standards of many households, whereby many of the households not being previously considered as poor, were pushed into poverty.
However, poor and low-income households were most affected by the price crisis. World Bank staff indicates that, in developing countries, households in the bottom decile of the consumption distribution faced inflation higher by two percentage points than those faced by households in the top decile, with the difference reaching 5 percentage points in some countries. As for more developed economies, this difference between the poorest and wealthiest households was lower (around 1.6 percentage points). In our country, according to the World Bank Report on the Western Balkans, the poorest households faced inflation, higher by 3.8 percentage points than the average, or by 6.6 percentage points more in relation to households in the top decile of the consumption distribution. Reason for such differences lies in the fact that lower-income households tend to concentrate their consumption expenditure in fewer goods and services than higher-income households. Analysis of the consumption of lowest-income households, demonstrates that it is mostly concentrated on food products and housing, and in line therewith, they are most affected by the latest price pressures as regards the commodities and the energy products. From the aspect of income redistribution, this crisis causes further deepening of the gap between rich and poor.
Inflation as a Reason for Redistribution of Income and Capital
Inflation shapes the redistribution of income and capital. It increases costs of living, thus having greater impact on the lower-income households and the poor, since essential goods account for great share of their family budget. Thereby, essential goods account for a lower share in the family budget of higher-income households. On the other hand, value of assets increased, since demand therefore increases in times of crisis, as “safeguarding” the money value amid inflation, i.e. when prices increase. Hence, wealthy families with investments in real estate become even wealthier. Funds are allocated through income redistribution from those who are less well off and would spend funds for their essential needs to those who are better off and would save the funds, or according to Nobel Prize Winner Joseph Stiglitz, “we have reallocated funds from those who would spend them to those who would not”. This leads to further deepening of the gap between the social strata of the society. In 2020, according to the recent available data published by the State Statistical Office, at-risk-of-poverty rate increased by 0.2 p.p. as a percentage of the population, i.e. from 21.6% to 21.8% (Laeken indicators). The reason for this was the pandemic, when at-risk-of-poverty rate increased following several-year decline (in fact, the rate has significantly declined by almost 6 p.p. over the last ten years). As indicated above, unemployment rate continued dropping in 2020, however, Gini coefficient of income inequality surged by 0.7 p.p.. It is worth mentioning that even in times of crisis, in the period 2020-2023, as a result of the sound policies of the Government aimed at retaining jobs and job creation, unemployment continued declining, reaching the lowest level so far (14.4%). Compared to EU (last available data for 2021), at-risk-of-poverty rate is close to its average (21.7%), hence the discrepancy between the Member State is large, ranging from 34% in Romania to 10% in Czech Republic. Percentage of at-risk-of-poverty rate increased in 2020. Gini coefficient in the EU is also around 30%, while unemployment rate, according to the latest data for February 2023, is at the lowest level in the last 15 years, accounting for 6%.
Redistribution occurs among the economies as well. Higher inflation leads to less competitive prices of products, with the net export accordingly declining as the inflation grows higher. When goods are produced more cheaply abroad, import increases in the national economy. From a microeconomic point of view, price increase leads to increase of companies’ income, at the same time causing for input costs, which affect the profit they generate, to simultaneously surge. With respect to the economic activity and the investment cycle, inflation expectations affect the business cycle. When price increase is expected, investments also scale up as a result of the benefits the businessmen gain from the difference in the purchase and the selling price (the traders) or the inputs and the finished products (the producers). This also leads to increased profit margins, more evident at the traders due to the faster turnover of capital. According to the statistical data in our country, this is evident through the scaled-up investments (by around 7%) in the second half of 2022. Slowdown is expected in Q1 2023 as a result of the increased inventory last year, when the inflation experienced an upward trend. Downward trend is registered in 2023 already, and businessmen expect such trend to continue, hence they reduce their inventory, accordingly and their investments, which reflects on the economic activity and GDP growth. In addition, continuous growth of FDIs was registered on quarter-to-quarter basis in the course of 2022, partially as a result of the reinvested profit and the increased inventory, but also due to the scaled-up investment cycle following the COVID-19 induced crisis and attracting new FDIs.
I have recently read a very interesting analysis on the correlation between inflation and profit margins, based on data of Eurostat and Bloomberg Analytical Center, emphasizing that countries with the highest profit margins also experience the highest inflation in Europe, such as Lithuania, Ireland, etc. European Central Bank has also observed that high profit of companies pushes up prices and wages. This generalizes the exceptions, however it is interesting for a scientific debate and for the economic policy makers. Thereby, the business community is to be given recognition for the displayed resilience to the crisis and the courage to invest, as well as the innovation in their business solutions. There is always a new opportunity with crisis.
Inflation also affects the creditor – debtor relation, hence in case of unexpected inflation, the real value of the debt declines in relation to its initial value, and the real interest cost drops amid fixed interest rates. To the end of offsetting this effect, the banks compensate the possible losses due to asset devaluation in relation to the liabilities in their balances through higher deposit interest rates compared to lending interest rates on deposits, thus yielding higher profit margins in the short term. National Bank data show that banks yielded higher profit in Q1 2023 in relation to the previous year.
Inflation also entails other financial, economic and social costs, such as currency speculations, higher trade margins, higher investment uncertainty, increased poverty and many other aspects, but given the limited space allotment for writing, I will tackle these topics in one of my next columns. Below I will briefly elaborate about the international and our experience, recommendations and planned economic policies and measures to manage the crisis and maintain the economic growth.
Recommendations and Experience from Economic Policies for Managing the Crisis and Maintaining the Growth
Considering the negative effects of the inflation, global economy expectations for the coming few years are that policy creators will focus on fighting inflation at any cost – until reaching the target inflation. The right step to take in the fight against inflation is to stabilize inflation expectations and restrain the inflation spiral by tightening both the monetary policy with higher interest rates and the fiscal policy by prudent public spending. Price paid for such policies is slow down in economic growth in the short term. But, sound fiscal and monetary policies, coupled with structural reforms, will at the same time imply a stable macroeconomic environment for a sustainable economic growth in the short term.
To the end of mitigating the effects of the crisis amid fiscal consolidation, targeted assistance to vulnerable categories and subsidized electricity price for the households will continue to apply. Increased minimum wage and introduction of a mechanism for its adjustment to the costs of living and the increase of the average wage is a systemic solution aimed at protecting the low-income households against the inflation. Very soon, two minimum wages will be enough to pay for a basic expenditure basket, compared to few years ago, when three minimum wages were needed to pay for the same goods. Similar mechanism has been introduced under the amendments to the Law on Pension and Disability Insurance and the Law on Administrative Servant, all to the end of adjusting the minimum wage. Activities are undertaken for a new legal solution to regulate the wages in the entire public sector, thus preserving the living standard and adjusting them to the economic growth. Yet another mechanism to protect the vulnerable categories is the guaranteed minimum income, as well as a series of measures, such as the energy poverty reduction measure, etc. In addition, support to strategic agricultural products has been enhanced, all to the end of ensuring sufficient domestic production. Small- and medium-sized enterprises were supported, with support in the form of electricity price subsidies also extended to the one most affected by the price and the energy crisis, and favorable credit lines for liquidity and energy transition. Around EUR 225 million (1.5% of GDP) is projected in this year’s Budget, as a buffer for anti-crisis measures, which funds will be used if needed.
Our goal, in addition to managing the effects of the crisis, remains to be the economic growth and better living standard of the citizens. Downward trend in unemployment and trend of rising wages will continue, with the productivity growth still remaining as a great challenge. Support to active labour market measures is increased, aimed at job creation, and new measures for supporting the youth in the working process are implemented, as is the effective measure “Youth Guarantee”. We continue implementing sound economic policies and reforms to the end of boosting the competitiveness of our economy by improving infrastructure, business climate, rule of law, digitalization, green transition and energy independence, as well as strengthening human capital as key component for the economy’s growth and development.
Amid disrupted global value chains and geo-economic fragmentation, a possibility opens to attract new foreign direct investments, which will additionally underpin the economic growth in future. We continue implementing the programs for supporting the domestic and the foreign investors, focusing thereby on those that bring higher value added to the production, as well as employ highly professional and skilled personnel.
Last but not least, we remain strongly committed to EU accession, which is of exceptional importance for the development perspectives of our country and will further boost country’s economic growth and development in future.
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