Balkan Spring

The Balkans are back in the news recently with anti-government demonstrations in Albania, Montenegro, Bosnia and Herzegovina, Serbia and Bulgaria. Protesters railed against organized crime, corruption and poor transparency. There are also increasing investor doubts about Romania, which experienced numerous anti-government demonstrations last year and now holds the EU presidency. Its PSD-led government has dismayed Brussels and other EU countries by seeking to block its highly effective former chief prosecutor, Laura Codruta Kovesi (until the PSD removed her), from becoming the first EU chief prosecutor. Yet she remains Brussels’ first choice.

The PSD’s desperate efforts speaks volumes about its alleged abuse of power. The country’s powerful head, Liviu Dragnea, is banned from being premier due to corruption charges. Separately, there is dismay about the government’s hefty “greed taxes” on banks, which may impact investment and growth in the sector.

Away from the headlines there is, however, another narrative. The promise of EU membership coupled with rising living standards and growing foreign direct investment (FDI)—particularly investment that reinforces links to the European supply chain—are gradually transforming the Balkan region into one of Europe’s most dynamic areas.

Nevertheless, these economies are expected to slow. The European Bank for Reconstruction and Development (EBRD) anticipates the region will enjoy GDP growth of 3.2% this year, compared with 3.5% in 2018. Growth in Romania, the region’s largest economy, will slow to 3.6% this year, down from 4.2% in 2018. That is still higher than most economies in Western, Central and Eastern Europe, many of which face a flat or negative outlook this year. In addition, investment is increasing as these Balkan economies grow in appeal to investors with their low wages and slowly improving infrastructures. The countries’ access to the large EU market also helps lure investors.

Meanwhile, investors and the EU are pressuring Balkan governments to improve transparency and local business environments and undertake reforms to bolster judicial systems and other areas important to the economy and investors.

So what might 2019 have in store for the Balkan region?

With the international community applauding the agreement between Athens and Skopje that confirms North Macedonia as a new legal entity, allowing negotiations on North Atlantic Treaty Organization (NATO) membership to conclude, observers are now hoping that the EU will honour its promise to start the accession process for Skopje.

“Failure to follow through on what was an implicit promise would put Prime Minister Zoran Zaev in a very precarious position and undermine his reform program,” says James Ker-Lindsay, a specialist in Southeast Europe at the London School of Economics and Political Science. Ker-Lindsay says the hope now is for progress on the region’s two other significant unresolved issues: the increasingly dysfunctional situation in Bosnia and Herzegovina and the stand-off between Serbia and Kosovo. That standoff emerged last year after plans by Serbia’s Prime Minister Aleksander Vucic and Kosovo’s President Hashim Thaci for a land swap seem to have stalled amidst serious domestic opposition.

“Normalization of relations would boost investment in both countries, weaken Russia’s capacity to make trouble here and bolster relations with the EU,” Ker-Lindsay says, adding that most Serbs support the government’s goal of EU membership.

After a poor performance in 2017, Serbia’s economy has been picking up, with FDI now accounting for around 5% to 6% of GDP, enough to cover the current account deficit. The fiscal deficit has been reduced from 6.6% to 0.5%. Although concerns remain about weak and volatile growth and the rule of law, Peter Tabak, regional lead economist at EBRD. says investor interest remains strong in Serbia, the western Balkans’ largest economy.

“Companies are looking at a wide range of sectors, mainly manufacturing … but also in IT services,” says Tabak. Longer term, he adds, Serbia can grow close to 4% to 5% a year, converging with the EU average, given successful structural reform.

Although global merger and acquisition (M&A) activity is at a low point, Serbia and some of the smaller Balkan countries have had a wave of M&A activity. Low valuations, particularly in the information and communications technology sector but elsewhere too, are attracting investors.

According to a new report published by global law firm Cameron McKenna Nabarro and UK-based emerging-markets information specialist EMIS, Serbia saw deal volume jump a record 40% last year while deal value increased by 737%. This year’s planned sale of Komercijalna Banka, the second-largest bank, should further whet investor appetites. Meanwhile, Albania saw a 1,050% rise in deal value and 300% uptick in deal volume last year. It expects to sell off Telekom Albania this year.

Tabak expects interest in North Macedonia, where GDP is expected to grow around 3% as trade and investment from Greece increase. In Montenegro, strong tourism will support growth as long as infrastructure improvements continue.

Bulgaria, by contrast, is expected to experience slowing growth that remains above the EU average. “We witnessed high growth in business services and IT sectors. Employment has improved, as have salaries and consumption,” says Alex Bebov of BAC-Bulgaria. “Compared with previous years, we see more opportunities for M&A: the positive economic developments, the continued availability of cheap funding, the coming to a close of some financial investors’ holding periods, as well as the higher level of segmentation of some of the markets—financial institutions, broadband, pay TV.”

After several years of high growth, supported by loose fiscal and monetary policy and high levels of FDI and capital transfers from the EU’s structural funds, Romania is in a wait-and-see mode. The presidential election is scheduled for November and parliamentary elections are scheduled for next year, if not before, and the economy is expected to slow. “No one is expecting much in the way of IPOs or privatisations until the end of the current electoral cycle,” says Dan Visoiu of BAC Romania.

Not that Romania really needs them right now. The Balkans’ biggest economy has seen a wave of investment into sectors like agribusiness, healthcare, pharma and ICT, with robotics tech firm UiPath emerging as the country’s first $1 billion unicorn, with offices around the globe. Western companies are also increasingly using Romania for back office activities, taking advantage of the English-speaking populations in the key Romanian cities of Bucharest, Cluj and Timisoara. Although GDP growth is slowing, local consumption should remain strong with the high wages produced by labour shortages.

“Romania’s biggest problem is its government,” says Visoiu, pointing to the hefty new taxes imposed on the banking sector and telecoms. The EBRD also expressed worries about the taxes, particularly the high rate: 0.3% per quarter, or 1.2% a year, much higher than any equivalent elsewhere. Jakov Milatovic, principal economist at EBRD, says there is a wider deterioration in the business climate. Last year Romania dropped seven places to 52nd in the World Bank Doing Business survey. Only Bulgaria, dropping nine places to the 59th position, fared worse. “Momentum here must be regained,” he says, noting that the European Commission’s Cooperation Verification Mechanism for Bulgaria and Romania—which seeks to improve the rule of law—is still in place, twelve years after the two countries joined the EU. “Nobody could have expected the mechanism to be in place after all this time,” he adds.

Such worries aside, most observers remain broadly upbeat, including Arvind Ramakrishnan, Romania analyst at Fitch Ratings. “We give it a stable outlook, with the risks broadly balanced. Convergence will continue, but it will be a slow, gradual process,” Ramakrishnan adds.

However 2019 and 2020 pan out, investors concerns in all the Balkan countries will continue to focus on corruption, the deteriorating business climate of some countries and demographic 7worries. A declining birth rate, compounded by high levels of emigration and areas of mismatched skills, are undermining the region’s otherwise strong foundation of human capital. Unresolved domestic political tensions and increasingly high debt levels are other concerns.

But in the short term, one of the biggest challenges is the slowdown in the wider EU, on which the Balkan region, with its open economies, is highly dependent for trade and investment. “This is something we are watching very closely,” says Paul Gamble, director of the sovereign group at Fitch Ratings. Assuredly, investors and multinationals are watching too.