Inflation concerns dampen economic outlook
After a strong economic recovery in 2021, the economic outlook in Kosovo is less favourable as GDP is expected to grow merely by 2.8%. Although the current war in Ukraine has no direct impact on Kosovo via trade and financial channels, higher import prices for energy and food can be identified as the main reason leading to an inflation jump to 14.2% in July 2022.
The current account deficit remains high in 2022, due to higher import prices for energy and food. The strong dynamics in foreign trade in 2021 are likely to continue in 2022. Remittances remain very resilient and strong in 6M2022, despite the tense situation in countries of origin. In addition, a higher fiscal burden is expected this year, due to higher electricity import prices.
The short-term outlook for Kosovo is not favourable. Much needed structural reforms in the medium and long-term could protect the economy more efficiently from future crises.
Background
The economic rebound in 2021, driven by consumption, investment, and exports (including diaspora related tourism), cannot be sustained in 2022. Record-breaking inflation rates negatively affect public and private consumption and slow down the pace of economic growth. In fact, higher import prices for energy and food, whose demand is inelastic, create a financial burden for households, firms and the government likewise. In addition, a negative contribution of net exports and modest investment due to uncertainty lead to a growth forecast of 2.8% for 2022 and 3.9% for 2023. This is comparable to other countries in the region.
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Inflation
Driven by the war in Ukraine, Kosovo experienced a strong increase in inflation in July this year at 14.2% due to higher oil, wheat and import prices for electricity. In fact, Kosovo features the highest inflation in the region in 2022. This can be explained by the comparatively high share of food and energy in the CPI consumer basket (almost 40%). Kosovo is particularly affected by the high import prices, as the low GDP per capita does not allow a broad and diversified consumer basket. The inflationary pressure can only be partly tackled as there is limited space for monetary policy due to the use of the Euro as a legal tender. The overall outlook for 2022 is concerning with an average inflation forecast at 9.5%.
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Labour market and wages
In general, the labour market benefits from wage flexibility in the context of the use of the Euro and current real effective appreciation. The average gross and net salary increased in 2021 by 4% after wages went down in 2020 during the pandemic. This increase partly makes up for the inflationary pressure. In particular, the minimum wage has been increased from EUR 170 to EUR 250 in April 2022. This has a positive effect on approximately 100,000 workers, but it also implies a reduction of the necessary wage flexibility.
Remittances
A strong increase to EUR 1.1 bn (+15.7% yoy), equivalent to 15% of GDP, could be observed in 2021. This trend continues in 6M2022, despite a tense situation in countries of origin. Remittances from Ukraine and Russia are negligible, which is a key difference to many countries in Eastern Europe and the South Caucasus. As a result, remittances in Kosovo are very resilient and can function as a shock absorber during crises.
Public finances
Due to improved revenue performance, the budget deficit decreased to 1.5% of GDP in 2021 and is expected to increase to 3.2% of GDP in 2022. The main reason are the additional expenditures due to higher electricity import prices in combination with fixed and subsidised prices. The debt ratio is expected to stabilise at 22.5% of GDP in 2022, where domestic debt is about 2/3 of total debt and practically all debt is in Euro, on the back of use of Euro in Kosovo.
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Outlook
Although there is no direct economic effect of the war in Ukraine on Kosovo, the unprecedented increase in international prices of food and energy will inevitably affect consumption patterns and general economic activity in 2022. Due to fixed and subsidised electricity prices, the fiscal burden will be significant. Thus, the outlook is less optimistic than in the beginning of the year. Strong remittances and the increase in the minimum wage will help vulnerable households to cope with inflationary pressure in the short-term.
However, medium and long-term structural changes need to be tackled. In particular, the implementation of an efficient energy system, FDI attraction, higher export of goods and the optimal organisation of economic zones could lead the country into a more prosperous economic future with improved macroeconomic and financial stability. The German Economic Team covers all these topics since September 2021 and cooperates closely with the government.
This Newsletter is based on the third issue of the Economic Monitor.
