Ongoing economic growth – key drivers and risks

Together, these factors more than outbalanced low public investment activities and the negative terms of trade shock driven by surging prices for imported commodities. In contrast, public consumption and investment activities are both projected to be the main growth drivers in 2023.

Background

After a strong post-Covid recovery in 2021, growth in Kosovo slowed down in 2022 but remained at a very decent rate of 3.5%. For 2023, growth of a similar magnitude is estimated at 3.8% – making Kosovo the country with the highest projected real GDP growth rate in the Western Balkan region.

In 2023, growth is mainly driven by strong public consumption and investment activities, both of which have resumed after having stalled in 2022. These driving factors behind the positive growth developments in 2023 are very different from those observed in 2022. In the previous year, diaspora-related economic activities in the form of remittances and tourism-driven service exports were the key drivers for the country’s economic performance. As such, they more than outbalanced negative influences on economic growth such as low public investment and the negative terms-of-trade shock driven by surging prices for imported commodities.

Inflation

In the wake of Russia’s war in Ukraine, 2022 saw massive international price increases for key consumption goods such as food and energy. Given that these goods make up around half of Kosovo’s CPI basket, the country experienced a surge in inflation. With an average of 11.6%, Kosovo had one of the highest inflation rates in the whole region in 2022. This impacted growth through a reduction in real income and thus private consumption as well as an increase in input prices and thus decline in investment. Furthermore, surging import prices following inflationary pressures in the whole region as well as the EU and the associated terms-of-trade shock exerted additional negative influences on economic growth in 2022 (see below). Thereby, inflation emerges as one of the key negative drivers of growth in Kosovo in 2022. Interestingly, this implies a negative short-term relationship between inflation and growth, unlike predicted by classic economic models such as the Phillips curve.

In 2023, inflation is projected to ease substantially, thus playing a much smaller role for economic growth. This projected ease is already observable with inflation amounting to a mere 3.2% yoy in August 2023.

Foreign trade

As a net importer of food and energy, the increases in international commodity prices of 2022 also affected Kosovo’s economy through a severe terms-of-trade shock. Surging import prices caused a major increase in goods imports, amounting to 11% of GDP. This import shock further exacerbated the traditional deficit in the merchandise trade balance, thereby negatively impacting economic performance in 2022.

The negative terms-of-trade shock in 2022 was outbalanced by significant increases in service exports. This increase was mainly driven by increasing tourism revenues, amounting to 20% of GDP. Especially diaspora-related tourism played a key role in this regard.

In 2023, goods imports are expected to increase even further, despite easing developments of global commodity prices. This is mainly due to increasing investment and FDI activities in the country, implying an increased demand for imports. At the same time, however, the positive trend regarding service exports driven by (diaspora)tourism is also expected to continue, albeit at a slower pace.

Remittances

In addition to service exports, remittances were another key economic activity related to the Kosovar diaspora that served as a buffer against the adverse economic developments following global price increases in 2022. Despite the tense economic situation in the main destination countries of the Kosovar diaspora, remittance inflows remained resilient in 2022, amounting to 13% of GDP. Thereby, remittances can be identified as an important economic driver, financing for instance consumption. For 2023, the increasing trend in remittances is expected to continue, albeit at a slower pace.

Public finances

Despite a notable increase in public expenditures on transfers and subsidies in 2022 (31.4% yoy) to mitigate the effects of soaring prices for key commodities, no new public deficit was generated in 2022. This, however, came at the expense of low public investment activities, thereby impeding upon economic development in 2022 and posing mid- to long-term risks to the growth of the economy and of companies dependent on public investment (e.g. construction sector).

In 2023, public expenditure is expected to pick up again and increase by almost 20% yoy. The main drivers of this re-acceleration are an increase in capital expenditure (60% yoy) and expenditure on goods and services (35% yoy), following positive developments such as the re-instantiation of the public procurement review body.

Outlook

Despite a challenging global environment, Kosovo continues to experience considerable economic growth in 2023. However, different factors can be identified as the driving forces behind the economic developments in 2022 and 2023. While this favorable economic development trend is expected to continue in 2024 with a forecast of 4.0% real GDP growth, challenges related to both current developments and structural factors remain. This includes restriction to trade flows in the context of ongoing geopolitical tensions as well as associated perception effects. In addition, structural challenges, relating e.g. to the continuous significant current account deficit in the and varying execution levels of public investment, stand out and will have to be closely monitored and tackled in the future.

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This Newsletter is based on the fifth issue of the Economic Monitor Kosovo.